IRA or 401k: What Are the Main Differences?
Discover how 401(k)s and IRAs differ in their fundamental structure, from employer sponsorship to the level of control you have over your retirement savings.
The 401(k) plan and the Individual Retirement Arrangement (IRA) are two of the most common retirement accounts in the United States. Both offer tax advantages to help individuals save for the future, but they operate differently. Understanding their distinct structures, contribution rules, and investment frameworks is important for developing a personal retirement strategy. This choice impacts how much is saved, how it grows, and how it can be accessed in retirement.
Understanding the 401(k) Plan
A 401(k) is an employer-sponsored retirement plan where participation is tied to employment. Contributions are made through automatic payroll deductions, which simplifies the process of saving. A common feature of 401(k) plans is the employer match, where an employer contributes to an employee’s account based on the employee’s own contributions, which can accelerate savings growth.
Employer contributions are often subject to a vesting schedule, a timeline determining when the employee gains full ownership of the matched funds. Vesting can be structured as “cliff vesting,” where an employee is 100% vested after a set period, or “graded vesting,” where ownership increases over several years. An employee is always 100% vested in their own contributions.
Employers may offer two types of 401(k)s: Traditional and Roth. Contributions to a Traditional 401(k) are pre-tax, reducing current taxable income. In contrast, contributions to a Roth 401(k) are made with after-tax dollars, meaning they do not lower current taxable income, but qualified withdrawals in retirement are tax-free.
Understanding the Individual Retirement Arrangement
An Individual Retirement Arrangement (IRA) is a personal retirement account that anyone with earned income can open, independent of an employer. Because it is not tied to a specific job, an IRA is portable and remains with the individual throughout their career. The account holder chooses the financial institution where the IRA is held.
The two primary types are the Traditional IRA and the Roth IRA. Contributions to a Traditional IRA may be tax-deductible, depending on the individual’s income and access to a workplace retirement plan. These deductions lower taxable income for the year, and investments grow tax-deferred until withdrawals in retirement are taxed as ordinary income. Contributions to a Roth IRA are not tax-deductible and are made with after-tax money. The primary benefit is that investments grow tax-free, and qualified withdrawals in retirement are also tax-free.
Key Distinctions in Contributions
Contribution rules for 401(k)s and IRAs differ significantly. For 2025, an employee can contribute up to $23,500 to a 401(k), while the IRA contribution limit is $7,000. These limits are subject to cost-of-living adjustments in future years.
Both accounts permit “catch-up” contributions for individuals aged 50 and over. For a 401(k), the catch-up amount is an additional $7,500 per year, with a higher limit of $11,250 for those aged 60 to 63. For an IRA, the catch-up contribution is $1,000.
Another distinction involves income limitations. The ability to deduct Traditional IRA contributions or contribute directly to a Roth IRA can be limited by an individual’s modified adjusted gross income (MAGI). In contrast, the ability to contribute to a Traditional or Roth 401(k) is not limited by income.
A key difference is the treatment of employer matching funds in a 401(k). These employer contributions do not count against the employee’s annual limit. The total combined contributions from both the employee and employer into a 401(k) have a separate, higher limit of $70,000 in 2025.
Investment Options and Control
The investment options and level of control differ between a 401(k) and an IRA. A 401(k) plan offers a limited menu of investment options selected by the employer, which consists of a handful of mutual funds across various asset classes. Many plans also feature target-date funds that automatically adjust their asset allocation as the retirement date nears, offering a hands-off approach.
An IRA opened at a brokerage firm provides a much broader universe of investment choices, giving the individual complete control to build a customized portfolio. An IRA holder can invest in:
- Individual stocks
- Bonds
- Exchange-traded funds (ETFs)
- Mutual funds
- Real estate investment trusts (REITs)
Rules for Withdrawals and Distributions
Withdrawal rules are structured to encourage long-term saving. For both 401(k)s and IRAs, withdrawals made before age 59½ are subject to a 10% early withdrawal penalty on top of any applicable income taxes. While some exceptions exist, the penalty discourages early access to funds.
A rule for traditional accounts is the Required Minimum Distribution (RMD). Individuals must begin taking withdrawals from Traditional 401(k)s and Traditional IRAs once they reach age 73 or 75, depending on their birth year. The RMD amount is based on the account balance and the owner’s life expectancy.
An advantage of Roth accounts is that they are not subject to RMDs for the original owner. This allows funds in a Roth IRA or Roth 401(k) to continue growing tax-free for the owner’s entire lifetime if the money is not needed.
The ability to borrow against retirement savings is a feature unique to 401(k) plans. Many plans allow participants to take out loans of up to 50% of their vested balance or $50,000, whichever is less. These loans must be repaid with interest, whereas IRAs do not permit loans.