How Are the Two Types of IRAs Different From 401(k)s and Each Other?

Planning for retirement involves choosing between different tax-advantaged accounts, with IRAs and 401(k)s being two of the most common options. Each has specific rules regarding contributions, taxes, and withdrawals that impact long-term savings. Understanding the differences between Traditional and Roth IRAs—and how both compare to 401(k) plans—helps individuals make informed investment decisions.

Traditional IRA: Contribution Limits and Tax Implications

A Traditional IRA allows for tax-deferred growth, meaning contributions may be tax-deductible, and taxes on investment gains are postponed until withdrawals begin. For 2024, the annual contribution limit is $7,000 for those under 50 and $8,000 for individuals 50 or older. These limits apply across all IRAs a person owns, not per account.

The deductibility of contributions depends on income and participation in a workplace retirement plan. If neither the account holder nor their spouse has access to an employer-sponsored plan, contributions are fully deductible. However, if covered by a workplace plan, deductions phase out based on modified adjusted gross income (MAGI). For single filers in 2024, the deduction phases out between $77,000 and $87,000, while for married couples filing jointly, it ranges from $123,000 to $143,000 if the contributing spouse is covered. If only the non-participating spouse contributes, the phase-out occurs between $230,000 and $240,000.

Withdrawals from a Traditional IRA are taxed as ordinary income, and distributions before age 59½ generally incur a 10% penalty in addition to income tax. Some exceptions exist, such as first-time home purchases (up to $10,000), qualified education expenses, and unreimbursed medical costs exceeding 7.5% of adjusted gross income.

Roth IRA: Contribution Caps and Tax Treatment

A Roth IRA offers tax-free withdrawals in retirement. Contributions are made with after-tax dollars, meaning there’s no immediate tax deduction, but investment growth and qualified withdrawals are tax-free.

For 2024, the total annual contribution limit remains $7,000 for individuals under 50 and $8,000 for those 50 and older. However, income restrictions apply. Contributions begin to phase out for single filers with a MAGI of $146,000 and are completely disallowed at $161,000. For married couples filing jointly, the phase-out range starts at $230,000 and ends at $240,000. Those exceeding these limits may still access Roth benefits through a backdoor Roth IRA strategy, which involves contributing to a Traditional IRA and then converting it to a Roth.

A Roth IRA allows contributions to be withdrawn at any time without penalties or taxes. Earnings, however, must remain in the account until at least age 59½ and meet the five-year rule to qualify for tax-free treatment. This five-year rule applies separately to each conversion from a Traditional IRA, which can impact tax planning.

Key Differences Between Traditional and Roth IRAs

Both Traditional and Roth IRAs offer tax advantages but differ in how and when taxes are applied, who can contribute based on income, and withdrawal rules.

Tax Timing

A Traditional IRA provides an immediate tax benefit by allowing deductible contributions, reducing taxable income in the year of contribution. However, withdrawals in retirement are taxed as ordinary income. This structure benefits individuals who expect to be in a lower tax bracket when they retire.

A Roth IRA does not offer an upfront tax deduction. Contributions are made with after-tax dollars, meaning there is no immediate reduction in taxable income. The advantage comes later—qualified withdrawals, including both contributions and earnings, are entirely tax-free. This can be beneficial for individuals who anticipate higher earnings in the future, as it eliminates the risk of paying higher tax rates on withdrawals.

For example, consider an individual who contributes $6,000 annually for 30 years and earns an average return of 7%. If they withdraw $600,000 in retirement, a Traditional IRA holder would owe taxes on the full amount, potentially paying over $100,000 in federal taxes depending on their bracket. A Roth IRA holder, however, would receive the entire $600,000 tax-free.

Income Eligibility

Anyone with earned income can contribute to a Traditional IRA, but the ability to deduct contributions depends on income and workplace retirement plan participation. In contrast, Roth IRAs impose direct income limits on contributions.

For 2024, single filers earning above $161,000 and married couples filing jointly with income exceeding $240,000 cannot contribute directly to a Roth IRA. These limits are based on MAGI, which includes wages, self-employment earnings, and investment income, with certain deductions added back. Individuals above these thresholds may still access Roth benefits through a backdoor Roth IRA conversion, but this requires careful tax planning.

Traditional IRAs do not have income restrictions for contributions, but deductibility phases out for those covered by an employer-sponsored plan. This means high earners may contribute but won’t receive an immediate tax benefit unless they qualify under the phase-out limits.

Withdrawal Conditions

Traditional IRAs require account holders to begin taking required minimum distributions (RMDs) starting at age 73, as mandated by the SECURE 2.0 Act of 2022. These distributions are calculated based on life expectancy and account balance. Failure to take RMDs results in a penalty of 25% of the required amount, though this can be reduced to 10% if corrected in a timely manner.

Roth IRAs do not have RMDs during the account holder’s lifetime, making them useful for estate planning. This allows funds to grow tax-free indefinitely. Beneficiaries, however, must withdraw the full balance within 10 years under the SECURE Act of 2019, unless they qualify for an exception.

Early withdrawals from a Traditional IRA before age 59½ generally incur a 10% penalty plus income tax. Roth IRAs offer more flexibility—contributions can be withdrawn at any time without penalty, and earnings can be accessed tax-free if the account has been open for at least five years and the account holder is 59½ or older.

How IRAs Differ from 401(k)s

Employer sponsorship distinguishes 401(k) plans from IRAs. A 401(k) is established by an employer, who may offer matching contributions, whereas IRAs are opened independently by individuals.

One of the most notable differences is the contribution limit. For 2024, employees can defer up to $23,000 into a 401(k), with an additional $7,500 catch-up contribution for those 50 and older. Employers may also contribute, bringing the total potential contributions—including employee deferrals and employer matches—to a maximum of $69,000 (or $76,500 for those 50 and older). In contrast, IRA contribution limits are significantly lower, capped at $7,000 ($8,000 for those 50 and older).

Investment flexibility is another key distinction. IRAs generally offer a broader selection of investment options, including individual stocks, bonds, mutual funds, and even alternative assets like real estate through self-directed IRAs. 401(k) plans, however, are limited to the investment options selected by the employer, often consisting of mutual funds and target-date funds. While this simplifies decision-making, it may restrict access to lower-cost or higher-return investments.