It’s easy to see why saving for retirement is essential. But what’s not always so simple is understanding how best to use different savings options to your advantage. That’s where retirement-specific investment accounts like 401(k)s and individual retirement accounts (IRAs) come in.
What’s the difference between IRAs and 401(k)s?
Both IRAs and 401(k)s offer tax advantages to help incentivize saving for retirement. The main difference between them is that you get a 401(k) plan through your employer, and you open an IRA through a bank or broker, like Ally Bank of Ally Invest.
Other differences involve investment flexibility and contribution limits. Generally, you have more alternatives for what you can invest in with an IRA, but 401(k)s allow for higher annual contributions.
401(k) vs. IRA at a Glance
|Employer Match||Sometimes offered||Not available|
|2021 Contribution Limit||$19,500 ($26,000 age 50+)||$6,000 ($7,000 age 50+)|
|Investment Choices||Limited by employer plan||Variety of choices|
|Eligibility||Not limited by income||Can be limited by income|
More to Know About a 401(k)
A plus for 401(k) plans is your employer typically offers to match some of your contributions. For example, they might match your contributions dollar-for-dollar up to 3% of your salary. It’s basically like getting additional compensation from your employer. That extra contribution could go a long way for you.
Another benefit is 401(k)s have significantly higher contribution limits than IRAs. The current limit is $19,500 annually (or $26,000 if you are age 50 or older).
Typically, you can make contributions through automatic payroll withholding, and earnings are tax-free until you withdraw during retirement. Like a traditional IRA, a 401(k) requires you begin withdrawing money — a.k.a. required minimum distributions — at age 72.
More to Know About an IRA
One of the best features of an IRA is its flexibility. You can use an IRA to supplement your 401(k) plan, or you can open one on its own. You can choose from three main types of IRAs, letting you tailor your savings strategy to your personal situation:
- Traditional IRAs allow you to deduct your contributions (subject to income levels). Your money is taxed when you take it out during retirement.
- Roth IRAs allow you to contribute after-tax dollars, so your distributions during retirement are tax-free. (See a detailed comparison of Roth vs. traditional IRAs here.)
- SEP (Simplified Employee Pension) IRAs are established by your employer or by you, if you’re self-employed. Contribution limits are higher than those for traditional IRAs.
It’s always a good idea to check the IRS website for up-to-date information about things like eligibility requirements and contribution and deduction limits and to consult with a tax professional when deciding what’s right for you.
Can I have both an IRA and a 401(k)?
Yes, you can have both an IRA and a 401(k) and doing so may be a great retirement savings strategy. If you find yourself maxing out your 401(k) and you need an additional way to save, IRAs may help you stash away another $6,000 to $7,000 per year (depending on your age and income level).
Read More: Which IRA Is Right for You?
In addition, opening an IRA gives you investment alternatives you likely don’t have in your workplace plan. First, you can choose between doing it yourself or using a robo-advisor. If you DIY, you have a variety of investment products to pick from, including mutual funds, exchange-traded funds (ETFs), and individual stocks and bonds.
You can also open IRA deposit products, like savings accounts and certificates of deposit (CDs), at a bank if you like the idea of a portion of your savings being FDIC-insured up to the maximum amount allowed by law, (so long as the bank you choose is insured).
Learn more: Ally Bank offers our Online Savings Account, High-Yield CD and Raise-Your-Rate CDs in our IRA plans.
Having an IRA and a 401(k) also lets you diversify your tax advantages, meaning some retirement savings is taxed up front and some is taxed as ordinary income when you pull it out. There are a lot of strategies you can employ when it comes to taxes and retirement savings, and talking with a tax professional can help you decide what’s best for you.
Which one should I fund first, the IRA or the 401(k)?
Whether you concentrate on putting your retirement savings into your 401(k) or IRA first depends on whether or not your employer offers to match your 401(k) contributions. For some, it might be a good idea to contribute enough to get the maximum match and then get started with IRA contributions.
If your employer doesn’t match contributions, you might choose to fund your IRA first (because you have more investment options), then put money in your 401(k).
Can I transfer my 401(k) into an IRA?
You can roll over your 401(k) into an IRA. You must follow certain rules, but rolling over your 401(k) can simplify your retirement savings by consolidating old 401(k) accounts, avoiding extra fees involved with your 401(k) plan or giving you access to the wider range of investment options available with IRAs.
Save for Retirement Your Way
Investing for retirement is a great way to set yourself up for future success. While there’s no right or wrong way, making the most of IRAs and 401(k)s may give your retirement savings an extra boost.
At Ally Invest, we offer IRAs for retirement savers in all situations.
This information is not, nor should it be, considered tax advice. We recommend that you consult with your tax advisor or other tax professional regarding any tax matters.