What’s the difference between a 401(k) and an IRA?
A 401(k) is an employer plan with a 2024 limit of $23,000 ($30,500 if 50+), often with a 3-6% company match. An IRA is an individual account you open at Vanguard or Fidelity with a $7,000 limit ($8,000 if 50+). Roth versions of both use after-tax dollars for tax-free retirement withdrawals. Fund the 401(k) match first, then max the IRA, then return to the 401(k).
In This Guide:
1. 401(k): Employer Plan Basics
A 401(k) is a retirement plan sponsored by your employer, with contributions deducted directly from your paycheck before taxes. The 2024 employee contribution limit is $23,000, or $30,500 if you are 50 or older thanks to a $7,500 catch-up. Many employers match contributions, typically 50 cents on the dollar up to 6% of salary, which is free money worth $1,500-$5,000 annually for the average worker. Traditional 401(k) contributions lower your taxable income now, with taxes paid in retirement. Roth 401(k) options use after-tax dollars for tax-free retirement withdrawals. Investment choices are limited to your plan's menu, often 15-30 funds with expense ratios of 0.05-1.00%. Loans and hardship withdrawals are possible but should be last resorts due to taxes and penalties.
- Contribute at least enough to capture the full employer match.
- Increase contributions 1% annually until you max out.
- Choose low-cost index funds from your plan menu.
- Use the $7,500 catch-up if you are 50 or older.
- Avoid 401(k) loans unless facing true hardship.
- 💡 Not capturing the full match is leaving free money on the table.
- 💡 Average employer match is 3-6% of salary; capture all of it.
2. IRA: Individual Account Basics
An IRA is an individual retirement account you open yourself at a brokerage like Vanguard, Fidelity, or Charles Schwab. The 2024 contribution limit is $7,000, or $8,000 if you are 50 or older. Traditional IRA contributions may be tax-deductible depending on income and workplace coverage; Roth IRA contributions are after-tax but withdrawals in retirement are tax-free. Roth IRA eligibility phases out above $161,000 single or $240,000 married filing jointly in 2024. IRAs offer far more investment choices than 401(k) plans: any stock, ETF, mutual fund, or bond the brokerage offers. You can withdraw your own Roth contributions anytime without penalty, but earnings withdrawn before age 59 and a half face taxes and a 10% penalty unless an exception applies.
- Open an IRA at Vanguard, Fidelity, or Schwab.
- Choose Roth if your income allows and tax rate is low.
- Pick low-cost index funds or ETFs like VTI or VOO.
- Contribute $583 monthly to max out by year-end.
- Use the $1,000 catch-up if you are 50 or older.
- 💡 Roth IRA contributions can be withdrawn anytime without penalty.
- 💡 IRAs offer far more investment choices than typical 401(k) plans.
3. Order to Fund Both
The optimal contribution order maximizes free money and tax advantages. First, contribute to your 401(k) at least enough to capture the full employer match; otherwise you leave 50-100% instant returns on the table. Second, max out a Roth IRA for its tax-free growth and flexible withdrawals. Third, return to your 401(k) and increase contributions up to the $23,000 limit. Fourth, fund a Health Savings Account if you have a high-deductible health plan, contributing up to $4,150 for individuals or $8,300 for families in 2024. Fifth, consider a taxable brokerage account for additional savings. This order works for most workers; high earners above Roth limits can use a backdoor Roth conversion. Revisit your contribution rates annually after raises.
- Contribute enough to 401(k) to capture the full match.
- Max out a Roth IRA ($7,000 in 2024) next.
- Return to 401(k) and increase up to the $23,000 limit.
- Fund an HSA if you have a high-deductible health plan.
- Open a taxable brokerage for any additional savings.
- 💡 Skipping the employer match is leaving free money behind.
- 💡 HSAs offer triple tax advantage: deduction, growth, and medical withdrawals.
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