401(k) vs. IRA: A Roth and Traditional Comparison
Clarify the key differences between employer-sponsored and individual retirement plans and learn how their distinct tax structures inform an effective savings strategy.
Utilizing tax-advantaged retirement accounts is a component of long-term financial strategy. A variety of accounts are available, each with distinct regulations, contribution limits, and tax implications. Understanding these differences is a step toward building a secure financial future. This article provides an analysis of the 401(k) and the Individual Retirement Arrangement (IRA), including their Traditional and Roth versions.
The Core Tax Distinction Traditional vs Roth
The core difference between Traditional and Roth structures is the timing of income tax. This distinction determines whether you pay taxes on contributions before they are invested or on withdrawals in retirement.
Traditional contributions are made on a pre-tax basis, meaning the money is deposited before federal and state income taxes are calculated. This action can reduce your taxable income for the year, resulting in a lower tax bill. For instance, if an individual earning $80,000 contributes $5,000 to a Traditional account, they are only taxed on $75,000 of income for that year.
The funds within the account, including all investment earnings, grow tax-deferred. No taxes are owed on the gains as they accumulate over the years. The tax obligation is realized in retirement, when any money withdrawn is taxed as ordinary income.
Roth contributions are made with post-tax dollars, meaning you have already paid income tax on the money. Using the same example, an individual earning $80,000 would pay taxes on the full amount and could then contribute $5,000 to a Roth account. There is no immediate tax deduction for making a Roth contribution. The benefit of the Roth structure emerges in retirement, as contributions and all associated earnings grow completely tax-free, and qualified withdrawals are not subject to income tax.
The Employer-Sponsored 401(k) Plan
A 401(k) is a retirement savings plan offered by an employer, allowing employees to invest a portion of their paycheck. The Internal Revenue Service (IRS) sets annual limits on how much an employee can contribute. For 2025, an employee can contribute up to $23,500 of their salary, and this limit applies to the total amount contributed across both Traditional and Roth 401(k) options.
A feature of many 401(k) plans is the employer matching contribution. A common matching formula is for the employer to contribute 50 cents for every dollar the employee contributes, up to the first 6% of the employee’s salary. These employer contributions are often subject to a vesting schedule, which dictates the timeline over which the employee gains full ownership of the matching funds, often ranging from two to six years.
Individuals age 50 and over are eligible to make additional “catch-up” contributions of $7,500 for 2025, allowing them to contribute a total of $31,000. A provision in the SECURE 2.0 Act also allows for a higher catch-up amount of $11,250 for those aged 60 to 63, beginning in 2025, if the plan allows it. Investment choices within a 401(k) are confined to a menu selected by the plan administrator, which consists of a limited number of mutual funds and target-date funds.
The Individual Retirement Arrangement (IRA)
An Individual Retirement Arrangement (IRA) is a personal retirement savings account that an individual can open independently of an employer. The IRS sets the annual contribution limit for IRAs, which is considerably lower than that for 401(k)s. For 2025, an individual can contribute a maximum of $7,000 to all of their IRAs combined.
Similar to 401(k)s, IRAs permit catch-up contributions for those age 50 and older. The IRA catch-up amount is $1,000, bringing the total possible contribution for this age group to $8,000 for 2025. Unlike the 401(k), there is no employer match associated with an IRA, as it is an individual account.
IRAs are available in Traditional and Roth varieties, but eligibility can be restricted by income. Anyone with earned income can contribute to a Traditional IRA, but the ability to deduct those contributions is phased out based on your Modified Adjusted Gross Income (MAGI) if you or your spouse are covered by a workplace retirement plan. For 2025, the deduction for a single filer covered by a workplace plan begins to phase out at a MAGI of $79,000 and is eliminated at $89,000.
The ability to contribute directly to a Roth IRA is also subject to MAGI limitations. For 2025, a single filer’s ability to contribute begins to phase out with a MAGI between $150,000 and $165,000. An advantage of IRAs is the expansive range of investment options, as an IRA holder can invest in a wide array of securities, including individual stocks, bonds, exchange-traded funds (ETFs), and thousands of mutual funds.
Side-by-Side Account Comparison
A 401(k) is an employer-sponsored plan, while an IRA is an individual account opened through a financial institution. Their features differ in several important ways.
Contribution Limits
The contribution limits for these accounts differ significantly. For 2025, the employee contribution limit for a 401(k) is $23,500, while the limit for an IRA is $7,000.
Employer Match
Many employers offer to match a certain percentage of an employee’s 401(k) contributions. This benefit is not available with an IRA.
Income Limitations
There are no income restrictions on who can contribute to a 401(k). For IRAs, the ability to deduct Traditional IRA contributions can be limited by income, and the ability to contribute to a Roth IRA is phased out for higher earners.
Withdrawal Rules
A 10% penalty is applied to withdrawals from most accounts made before age 59½. An exception exists for Roth IRAs, from which an individual can withdraw their direct contributions at any time, for any reason, without tax or penalty. This provides a level of flexibility not found in other retirement accounts.
Required Minimum Distributions (RMDs)
The SECURE 2.0 Act raised the age for RMDs to 73. These mandatory annual withdrawals apply to Traditional 401(k)s and Traditional IRAs. Roth IRAs and Roth 401(k)s are exempt from RMD rules for the original account owner, allowing the funds to continue growing tax-free for their entire lifetime.
A Framework for Prioritizing Contributions
Navigating where to save for retirement can be simplified by following a logical hierarchy. This framework is a strategic approach to maximizing retirement savings opportunities. The first step for anyone with access to a 401(k) that offers an employer match is to contribute enough to receive the full matching amount. Failing to do so is equivalent to declining a guaranteed return on your investment.
After securing the full employer match, the next consideration is contributing to an IRA. For those eligible, a Roth IRA is often the next priority due to its tax-free growth, tax-free withdrawals in retirement, and the ability to withdraw contributions without penalty. If an individual’s income is too high to contribute to a Roth IRA, they might then consider a Traditional IRA for its potential tax-deductible contributions.
Once the annual IRA contribution limit is reached, the focus should shift back to the 401(k). Savers can continue contributing to their 401(k) up to the much higher annual limit. This allows individuals to continue saving in a tax-advantaged manner after they have exhausted their IRA options for the year. After maximizing contributions to all available tax-advantaged retirement accounts, individuals with additional savings capacity can turn to a standard taxable brokerage account.