Traditional IRA vs. Roth IRA vs. 401(k): Which Is Best?
Choosing a retirement account is a strategic decision. Understand how differences in tax treatment, eligibility, and access to funds can shape your financial future.
The most common tax-advantaged retirement accounts are the 401(k), the Traditional Individual Retirement Arrangement (IRA), and the Roth IRA. Each account has a unique structure with different rules governing contributions, tax treatment, and withdrawals. Understanding these distinctions is a primary step in developing a retirement strategy that aligns with your personal financial goals.
Understanding the Three Account Types
A 401(k) is an employer-sponsored retirement plan where employees contribute through automatic payroll deductions, which simplifies the process of saving. Its availability is tied to a person’s place of employment. A significant benefit unique to this plan is that many employers offer a matching contribution.
Employers may offer two versions: a Traditional 401(k) and a Roth 401(k). The primary difference between them is the tax treatment of contributions and withdrawals, which determines whether you pay taxes now or in retirement.
A Traditional IRA is an account that anyone with earned income can open, independent of an employer. Its defining feature is tax-deferred growth, meaning contributions may be tax-deductible and taxes are paid on withdrawals during retirement.
The Roth IRA is another individual account available to those with earned income who meet certain income limits. Unlike a Traditional IRA, contributions are made with after-tax dollars, and qualified withdrawals in retirement are completely tax-free.
Contribution Limits and Eligibility Rules
The Internal Revenue Service (IRS) sets annual contribution limits. For 2025, an individual can contribute up to $23,500 to a 401(k), which can be split between Traditional and Roth options if available. The combined contribution limit for Traditional and Roth IRAs is $7,000 for 2025.
An eligible individual can contribute to both a 401(k) and an IRA in the same year, as the limits are separate. To help individuals boost their savings, the IRS also allows for catch-up contributions for those age 50 and over. For 2025, the additional catch-up amount is $7,500 for 401(k) plans and $1,000 for IRAs.
While anyone with earned income can contribute to a Traditional IRA, the ability to deduct contributions depends on income and coverage by a workplace retirement plan. For 2025, the deduction for single filers with a workplace plan phases out with a Modified Adjusted Gross Income (MAGI) between $79,000 and $89,000.
Direct contributions to a Roth IRA are also limited by MAGI. For 2025, the contribution ability for single filers phases out with a MAGI between $150,000 and $165,000. The phase-out range for those married filing jointly is between $236,000 and $246,000. There are no income limits for contributing to a Roth 401(k).
Tax Treatment of Contributions and Withdrawals
The main difference between these accounts is when you pay taxes. Contributions to a Traditional 401(k) are made on a pre-tax basis, meaning they are taken from your paycheck before income taxes are calculated. This action reduces your taxable income for the year. Similarly, deductible Traditional IRA contributions lower your taxable income by the amount you contribute, which also reduces your current year’s tax bill.
Contributions to a Roth 401(k) and a Roth IRA are made with post-tax dollars, meaning you have already paid income tax on the money. As a result, you do not receive an upfront tax deduction in the year of the contribution.
When you withdraw funds in retirement, the tax implications reverse. Qualified withdrawals from Traditional 401(k)s and Traditional IRAs are treated as ordinary income and are subject to federal and state income taxes. All withdrawals, including contributions and earnings, are taxed at your marginal tax rate in retirement.
Qualified withdrawals from Roth 401(k)s and Roth IRAs are completely tax-free. For a withdrawal to be qualified, it must be made after age 59½ and the account must have been open for at least five years. This tax-free treatment applies to both contributions and earnings. The choice between these accounts often depends on whether you expect your tax rate to be higher now or in retirement.
Regulations for Accessing Funds
You must generally be at least 59½ years old to withdraw money from a 401(k) or an IRA without penalty. Distributions before this age are subject to a 10% early withdrawal penalty in addition to ordinary income taxes.
Several exceptions to the 10% penalty exist, though income tax still applies to withdrawals from traditional accounts. Common exceptions for both IRAs and 401(k)s include distributions for:
- Total and permanent disability
- Certain medical expenses exceeding a percentage of your adjusted gross income
- Payments to a beneficiary after the account owner’s death
- Some higher education expenses
A notable difference between account types is that IRAs permit a penalty-free withdrawal of up to $10,000 for a first-time home purchase, an exception not available for 401(k) plans.
Another distinction involves Required Minimum Distributions (RMDs). The government requires you to begin taking withdrawals from Traditional 401(k)s and Traditional IRAs once you reach age 73. This ensures that the deferred taxes on these accounts are eventually paid. Roth IRAs, however, are not subject to RMDs for the original owner, allowing the funds to continue growing tax-free throughout their lifetime.
Investment Options and Employer Matching
A key difference between 401(k)s and IRAs is the range of investment choices. A 401(k) plan offers a limited menu of options selected by the employer, such as mutual funds and target-date funds. This simplifies decisions but restricts an investor’s ability to build a highly customized portfolio.
IRAs offer a much broader universe of investment possibilities. An IRA at a brokerage firm allows you to invest in nearly any security, including individual stocks, bonds, exchange-traded funds (ETFs), and mutual funds, providing greater control and portfolio customization.
A feature unique to 401(k)s is the potential for an employer match. Many companies match a portion of employee contributions, often dollar-for-dollar up to a percentage of salary. Because IRAs are individual accounts, they do not offer an employer match, so many professionals advise contributing enough to a 401(k) to receive the full match before saving in an IRA.