The main difference is that a 401(k) is an employer-sponsored account, so you can only participate in one if your job offers it as a benefit. Also, your company decides which investments are available, meaning you have limited control over what you can invest in and how much you pay in investment costs.
On the very bright side, you can often score free money with a 401(k). Many employers match a portion of employee contributions—adding 50 cents to $1 for every dollar you put in, often up to 6 percent of your total salary. So make sure you contribute enough to capture the full match and don't leave money on the table. In 2017, the contribution limit is $18,000 ($24,000 if you’re age 50 or older); in 2018, the limit is $18,500 ($24,500 if you're age 50 or older).
Meanwhile, almost anyone who’s earned income this year can open an Individual Retirement Account, or IRA. There are some restrictions to consider, though, based on what type of IRA you choose.
- To max out a Roth IRA, which allows you to withdraw money tax-free in retirement, you must have earned less than $118,000 in 2017, or $186,000 if you’re married and filing jointly. In 2018, you must earn less than $120,000, or $189,000 if you're married and filing jointly.
- To contribute to a traditional IRA, you must be under age 70½. (Roth IRAs have no age restrictions.)
- With a traditional IRA, the money you take out in retirement will be taxed, but the contributions you make may be tax-deductible, depending on your income as well as your (and your spouse’s) access to an employer-sponsored plan.
With an IRA, you have many more investment options—basically any stock, bond, mutual fund or exchange-traded fund offered by your brokerage. So you're free to diversify your portfolio and minimize costs as much as possible.
The downside of an IRA vs. a 401(k)? By itself, it probably won't be enough to retire on. The most you can contribute in 2017 and 2018 is $5,500 ($6,500 if you're age 50 or older).
If you’re trying to choose between one or the other, don’t worry about committing. Use both! Many experts recommend first contributing enough to your 401(k) to capture the company match, then maximizing your IRA contributions. After that, go back to maxing out your 401(k).
This story was updated in December 2017.
August 29, 2017