Comparing the Different Types of Retirement Accounts

Planning for retirement requires navigating various savings accounts, each with distinct rules. The options available in the United States are designed for different employment situations and financial strategies. Understanding these differences is a step toward building a secure financial future, from workplace plans to accounts an individual can open independently.

Understanding Employer-Sponsored Retirement Plans

Employer-sponsored retirement plans are a benefit offered by many companies, providing a structured way for employees to save. These accounts are established by employers, and employees can contribute a portion of their paycheck directly into the plan. The administration and investment options are managed by the plan provider selected by the employer.

The most prevalent type of employer-sponsored plan is the 401(k), found in for-profit businesses. A similar plan, the 403(b), is available to employees of public schools and certain non-profit organizations. In both, employees can contribute pre-tax or Roth (post-tax) dollars. For smaller businesses with 100 or fewer employees, the Savings Incentive Match Plan for Employees, or SIMPLE IRA, offers a more streamlined option that requires mandatory employer contributions.

A significant advantage of many employer-sponsored plans is the employer match. This is where the employer contributes to an employee’s account based on the amount the employee saves. A common matching formula is for the employer to contribute 50 cents for every dollar the employee contributes, up to 6% of the employee’s salary. This provides an immediate return on the employee’s investment.

The specifics of an employer match are determined by the plan’s documents and can vary. Some employers might offer a dollar-for-dollar match up to a lower percentage of salary. These matching contributions may also be subject to a vesting schedule, which dictates when the employee gains full ownership of the employer’s contributions. A vesting schedule might require an employee to work for the company for a certain number of years to become fully vested.

Understanding Individual Retirement Arrangements (IRAs)

Individual Retirement Arrangements, or IRAs, are retirement savings accounts that individuals can open on their own, separate from any employer. Eligibility to contribute to an IRA is dependent on having earned income from work. These accounts allow individuals to build their retirement savings with tax advantages, whether they are self-employed or simply want to save more than their workplace plan allows.

There are two primary types of IRAs: the Traditional IRA and the Roth IRA. The distinction between them lies in how they are treated for tax purposes, which centers on when you receive your tax benefit.

A Traditional IRA allows individuals to make contributions that may be tax-deductible. This means the amount you contribute could be subtracted from your taxable income for the year. The investments within the account then grow tax-deferred, and you do not pay taxes on the earnings each year. Taxes are paid when you withdraw the money in retirement, at which point the withdrawals are treated as ordinary income.

Conversely, a Roth IRA operates on a post-tax basis. Contributions are made with money you have already paid taxes on, so there is no upfront tax deduction. The benefit of a Roth IRA is that your investments grow completely tax-free. Consequently, qualified withdrawals in retirement are also tax-free. The decision between a Traditional and Roth IRA often depends on whether you expect to be in a higher or lower tax bracket during retirement.

Comparing Core Financial Features

Contribution Limits

The Internal Revenue Service (IRS) sets annual limits on the amount of money that can be contributed to retirement accounts. For 2025, employees participating in a 401(k) or 403(b) plan can contribute up to $23,500. Individuals aged 50 and over can make additional “catch-up” contributions of $7,500 per year. A new provision allows those aged 60 to 63 to make a higher catch-up contribution of $11,250 to these plans.

SIMPLE IRA plans have lower contribution limits. For 2025, the employee contribution limit is $16,500. The catch-up contribution for those aged 50 and over is $3,500, while those aged 60 to 63 can make a higher catch-up of $5,250.

Traditional and Roth IRAs have their own separate contribution limits. For 2025, the maximum contribution to an IRA is $7,000. The catch-up contribution for individuals aged 50 and over is an additional $1,000. This limit applies to the combined total of all Traditional and Roth IRAs an individual holds; you cannot contribute the maximum amount to each separately.

The total amount that can be contributed to a 401(k) or 403(b) plan, including both employee and employer contributions, is also capped. For 2025, this overall limit is $70,000. This means the sum of your own contributions, any employer match, and any other employer contributions cannot exceed this amount.

Tax Treatment of Contributions

The tax treatment of contributions is a defining difference between retirement accounts. As noted, Traditional 401(k) and Traditional IRA contributions are typically made pre-tax, lowering your current taxable income. Roth 401(k) and Roth IRA contributions are made post-tax, with no upfront deduction.

The ability to deduct Traditional IRA contributions can be limited by income. If you or your spouse are covered by a retirement plan at work, the deduction is subject to income phase-outs. For 2025, the deduction is phased out for single filers with a Modified Adjusted Gross Income (MAGI) between $79,000 and $89,000, and for married couples filing jointly with a MAGI between $126,000 and $146,000.

Eligibility to contribute to a Roth IRA is also subject to income limitations. For 2025, the ability to contribute is phased out for single filers with a MAGI between $150,000 and $165,000 and for married couples filing jointly with a MAGI between $236,000 and $246,000.

Taxation on Growth and Withdrawals

In traditional accounts, such as a Traditional 401(k) and Traditional IRA, your investments grow on a tax-deferred basis. You do not pay any taxes on interest, dividends, or capital gains as they are earned within the account. This allows your savings to compound more rapidly compared to a taxable brokerage account. When you begin taking withdrawals in retirement, the money is taxed as ordinary income.

Roth accounts, including the Roth 401(k) and Roth IRA, offer a different tax structure. The investments in a Roth account grow completely tax-free. You will not owe taxes on the earnings your account generates over the years.

The primary benefit of Roth accounts becomes clear at the withdrawal stage. Qualified distributions from a Roth IRA or Roth 401(k) in retirement are entirely tax-free. To be considered a qualified distribution, you must be at least 59½ years old, and the account must have been open for at least five years.

Rules for Accessing Your Money

Early Withdrawal Penalties

Accessing funds from a retirement account before age 59½ results in a penalty. The IRS imposes a 10% additional tax on early distributions from most retirement plans, including 401(k)s and Traditional IRAs. This penalty is in addition to the regular income tax you would owe on the withdrawal from a traditional account.

There are several exceptions to this 10% penalty, recognizing that individuals may face certain hardships. Common exceptions for both IRAs and 401(k)s include:

• Death or total and permanent disability
• Unreimbursed medical expenses that exceed 7.5% of your adjusted gross income
• Withdrawals made by a qualified military reservist called to active duty
• Qualified higher education expenses (IRAs only)
• Up to $10,000 for a first-time home purchase (IRAs only)
• Up to $5,000 for expenses related to a qualified birth or adoption

Even if an exception allows you to avoid the 10% penalty, you will still owe ordinary income tax on the withdrawal from a traditional account. For Roth IRAs, you can withdraw your own contributions at any time, tax-free and penalty-free. The 10% penalty would only apply to the earnings portion if taken early without a valid exception.

Required Minimum Distributions (RMDs)

To ensure that tax-deferred retirement savings are eventually taxed, the government requires account holders to begin taking withdrawals after a certain age. These mandatory withdrawals are known as Required Minimum Distributions (RMDs). The age at which RMDs must begin is 73, though it is scheduled to increase to 75 in 2033. RMDs apply to Traditional IRAs, 401(k)s, and 403(b)s.

The RMD amount is calculated annually based on your account balance and an IRS life expectancy factor. Failing to take your full RMD by the deadline can result in a penalty of 25% of the amount that should have been withdrawn. This penalty can be reduced to 10% if the mistake is corrected within two years.

Roth IRAs are not subject to RMDs during the original owner’s lifetime. This allows the funds to continue growing tax-free. For workplace plans like 401(k)s, there is a “still working” exception. If you are still employed by the company that sponsors your plan when you reach RMD age, you can delay taking RMDs from that specific plan until you retire.

Loans

Some employer-sponsored retirement plans, most commonly 401(k)s, offer the option to take out a loan against your account balance. This feature is not available from any type of IRA. A 401(k) loan allows you to borrow from your own retirement savings and pay it back to yourself with interest.

The IRS allows you to borrow up to 50% of your vested account balance, with a maximum loan amount of $50,000. The repayment period for a general-purpose loan is up to five years, with payments made through payroll deductions. A longer repayment term may be available if the loan is used to purchase a primary residence.

Taking a loan from your 401(k) has potential downsides. The money you borrow is no longer invested, so you miss out on any market growth. If you leave your job, your plan may require you to repay the entire outstanding loan balance in a short period. If you fail to repay the loan, the outstanding balance is treated as a taxable distribution and may be subject to the 10% early withdrawal penalty.