When Should You Open a 401(k) or IRA?

Deciding when to begin saving for retirement and selecting the appropriate account are important steps toward building long-term financial security. The two most common starting points for savers are the 401(k) and the Individual Retirement Arrangement (IRA). Each account offers distinct advantages, and the right choice often depends on individual circumstances, such as employment status and income.

Understanding Your Retirement Account Options

The 401(k) Plan

A 401(k) is a retirement savings plan sponsored by an employer, allowing employees to save and invest for retirement through direct payroll deductions. This automates the savings process. The money you contribute grows on a tax-deferred basis, meaning you won’t pay taxes on the investment earnings each year.

Employers may offer two types of 401(k)s: Traditional and Roth. Contributions to a Traditional 401(k) are pre-tax, lowering your current taxable income. For example, if you earn $60,000 and contribute $5,000, you are only taxed on $55,000 that year. Contributions to a Roth 401(k) are after-tax, but qualified withdrawals in retirement are tax-free.

The Internal Revenue Service (IRS) sets annual contribution limits. For 2025, the employee contribution limit is $23,500. Individuals age 50 and over can make additional “catch-up” contributions of $7,500. These limits are independent of any contributions made by your employer.

The Traditional IRA

A Traditional Individual Retirement Arrangement, or IRA, is a retirement account that anyone with earned income can open on their own, independent of an employer. This makes it an accessible option for freelancers, gig workers, or employees whose companies do not offer a retirement plan. You can open a Traditional IRA at most financial institutions, such as a bank or brokerage firm.

The main feature of a Traditional IRA is the potential for a tax deduction on contributions. Your ability to deduct contributions depends on your income and if you have a workplace retirement plan. Investments grow tax-deferred, and you pay ordinary income tax on withdrawals in retirement.

The IRS sets annual contribution limits for IRAs. For 2025, you can contribute up to $7,000. If you are age 50 or older, you can contribute an additional $1,000 as a catch-up contribution. This limit applies to the combined total of all your Traditional and Roth IRAs.

The Roth IRA

The Roth IRA shares the same contribution limits as the Traditional IRA but has a reversed tax structure. Contributions are made with after-tax dollars, so you do not receive an upfront tax deduction and your taxable income for the year is not reduced.

The main benefit of a Roth IRA is that qualified withdrawals in retirement are completely tax-free. This is advantageous if you expect to be in a higher tax bracket in retirement than you are now.

Eligibility to contribute to a Roth IRA is subject to income limitations based on your Modified Adjusted Gross Income (MAGI). For 2025, the ability to contribute phases 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. You cannot contribute directly if your income exceeds these limits.

Key Factors for Your Decision

Employer Match

The availability of an employer match in a 401(k) plan is a major factor in your retirement savings decision. An employer match means your company contributes to your account when you do. A common formula is a 50% match on the first 6% of your salary or a dollar-for-dollar match up to 3% of your salary.

This match is an immediate return on your investment before your money is even invested. Failing to contribute enough to receive the full employer match is equivalent to turning down free money. It is recommended to contribute at least enough to your 401(k) to capture the entire company match before directing funds elsewhere.

You should also understand your company’s vesting schedule, which determines your ownership of the employer’s contributions. While your contributions are always yours, you may need to work for the company for a specific period to gain full ownership of the matching funds.

Income and Tax Situation

Your current and expected future income are important for deciding between pre-tax (Traditional) and post-tax (Roth) accounts. The decision is based on whether you prefer to pay income taxes now or later.

If you are early in your career and expect your income and tax bracket to be higher in the future, a Roth account is often preferable. Paying taxes on contributions now, while in a lower tax bracket, allows for tax-free withdrawals in retirement when you may be in a higher bracket.

If you are in your peak earning years and expect a lower tax bracket in retirement, a Traditional account may be more advantageous. Pre-tax contributions reduce your taxable income now, deferring taxes until retirement when your tax rate may be lower.

The income limits for Roth IRA contributions are a direct constraint on this decision. High-income earners who are ineligible to contribute to a Roth IRA may find the 401(k) a more straightforward vehicle for retirement savings, especially the pre-tax option for an immediate tax reduction.

Investment Options and Flexibility

A 401(k) plan offers a curated menu of investment options selected by the plan administrator, often consisting of several dozen mutual funds. These can include target-date funds, index funds, and actively managed funds.

An IRA offers a much wider universe of investment possibilities. When you open an IRA at a major brokerage firm, you can invest in almost any publicly traded security, including individual stocks, bonds, exchange-traded funds (ETFs), and thousands of mutual funds. This flexibility allows you to build a highly customized portfolio.

This greater control is why some savers fund an IRA after receiving their 401(k) match. An IRA is suitable for investors who are comfortable managing their own portfolio and want more control over asset allocation.

Fees

All retirement accounts have fees, but their structure varies between 401(k)s and IRAs. 401(k) plans can have multiple layers of fees, including administrative, recordkeeping, and investment fees (expense ratios). These fees, which can be higher in plans from smaller companies, reduce your overall returns.

IRAs, especially those opened at low-cost brokerage firms, can be more cost-effective. Many firms charge no annual account maintenance fees, and investors can build portfolios using low-cost index funds and ETFs. Over a long-term investment horizon, even small differences in annual fees can compound into tens of thousands of dollars.

Your 401(k) plan must provide an annual fee disclosure statement detailing all costs. Comparing this document to IRA fee structures helps determine the most cost-efficient way to invest your money after securing an employer match.

A Prioritized Strategy for Opening Accounts

For most people with access to a workplace plan, a clear hierarchy exists for prioritizing contributions. This approach helps you take advantage of the most valuable benefits first.

• Contribute to your 401(k) up to the full employer match. The match is an immediate return on your investment, and capturing it should be your first priority.
• Open and fund an IRA. After securing the full 401(k) match, contribute to a Roth or Traditional IRA until you reach the annual limit. The choice depends on the income and tax factors discussed previously.
• Return to your 401(k). Once you have maxed out your IRA, contribute additional funds to your 401(k) until you reach the maximum employee contribution limit for the year.

If you do not have access to a 401(k), your priority is to open and fund an IRA up to the annual maximum.

The Process of Opening Your Chosen Account

Opening a 401(k)

You can enroll in your employer’s 401(k) plan when you start your job or during the annual open enrollment period. Contact your Human Resources (HR) department to get the necessary enrollment forms or a link to an online portal. You will need to decide your contribution amount per paycheck and select your investments from the plan’s menu.

Opening an IRA

You can open an IRA on your own at most banks, credit unions, and brokerage firms, often through a simple online process. You will need to provide personal information like your Social Security number to open the account. To fund it, you can link the IRA to a personal bank account for electronic transfers.