Although they are two of the most popular retirement savings vehicles, many employees aren’t clear on the difference between a 401(k) and an IRA (Individual Retirement Account)—which means they also don’t understand the benefits and drawbacks of each type of retirement account.
Individuals need to understand how each account works, however, because the distinction will enable them to make more informed decisions about retirement savings.
One common point of confusion we see among employees is the assumption that their workplace 401(k) is the same as an IRA or Roth IRA. Why? In our experience, many participants don’t understand the difference between the plan their employer offers, such as a 401(k), and what is available outside the plan, like an IRA.
When we deliver employee education presentations, we typically focus on helping employees understand their 401(k) account structure—especially the difference between Traditional and Roth contributions within the plan itself. But it’s just as crucial for individuals to understand when and why they might contribute to a 401(k) versus an IRA or Roth IRA. And when plan sponsors educate themselves on these differences, they can help employees make wiser retirement decisions.
What is a 401(k)?
A 401(k) is an employer-sponsored retirement plan that can only be offered by an employer. Contributions are made through payroll deductions, and employees determine their contribution amount. Many 401(k) plans also come with the added benefit of employer matching or profit sharing, which can significantly boost savings.
401(k) contributions can be either:
- Traditional (pre-tax)—meaning taxes are deferred until withdrawal in retirement, reducing taxable income for the year the employee contributes.
- Roth (after-tax)—meaning taxes are paid upfront, allowing tax-free withdrawals in retirement.
Both contribution types go into the same 401(k) account but are tracked separately for tax purposes. Employees often mistakenly believe they have a Roth IRA or IRA because of the Roth label, when in fact they’re just using the Roth option within their employer-sponsored 401(k) plan, not a separate IRA.
What is an IRA?
An IRA is an individual retirement account available to anyone with earned income, and is not connected to an employer. You can make contributions directly from your bank account.
Similar to 401(k), there are two main types of IRA contributions, depending on when you want the tax advantage:
- Traditional: Offers tax-deferred growth, which may be tax-deductible based on income
- Roth: Offers after-tax contributions, allowing tax-free withdrawals in retirement
IRAs tend to offer a broader range of investment options and flexibility in that you can find a provider that offers the types of investments you want.
Keep in mind that income limits apply for Roth IRA eligibility based on modified adjusted gross income (MAGI). For 2025, single filers earning less than $150,000 and joint filers earning less than $236,000 can maximize their Roth IRA contributions. Contributions begin to phase out above these levels and are completely phased out at $165,000 for single filers and $246,000 for joint filers.
Additionally, IRAs have lower annual contribution limits than 401(k)s. The 2025 401(k) contribution limit is $23,500 for those under 50 and $31,000 for anyone 50 years and older. This compares to $7,000 for those under 50 and $8,000 for anyone 50 years and older for an IRA.
401(k) vs. IRA: When to Contribute to Which
Still wondering when to take advantage of a 401(k) versus an IRA? It’s also pivotal that employers understand these pros and cons in order to educate their employees.
So, why contribute to a 401(k)? They offer:
- Easy and automatic payroll deductions and disciplined savings
- Higher contribution limits than IRAs
- Employer match—in other words, “free money”
- Potential for tax savings now (Traditional) or later (Roth)
Overall, 401(k)s provide retirement savings with minimal effort. Plus, you save the money before spending!
On the other hand, IRAs offer:
- A great option to further build your retirement savings if you’ve already maxed out your 401(k) contributions
- An alternative if your employer does not currently offer a 401(k) plan
- Greater investment flexibility and control
- Additional tax diversification in retirement
An IRA can be a good choice if your 401(k) has limited or expensive investment options—but if the plan sponsor is doing their fiduciary duty and partnering with a fiduciary advisor to offer an efficient, effective plan, this shouldn’t be an issue!
And yes, you can open an IRA in addition to your 401(k)—in fact, it’s often a great strategy to optimize your retirement savings. However, if an employer offers a match, we generally recommend employees contribute enough to maximize their 401(k) savings before considering additional IRA contributions.
Final Thoughts
Choosing between a 401(k) and IRA isn’t an either/or situation—many people can benefit from both, as discussed above. It’s a matter of how and when to use each account type, which can lead to a more secure retirement.
Employers, we encourage you to educate employees about their options and how these different types of accounts work. And employees, we encourage you to ask questions during plan presentations—of course, you can always meet with a financial advisor for personalized guidance! Reach out to speak with an FSRP advisor today to learn how we can help.
Securities and advisory services offered through Commonwealth Financial Network, Member FINRA/SIPC, a Registered Investment Adviser. Financial Strategies Retirement Partners (FSRP) is a Registered Investment Adviser. Financial planning services offered by FSRP are separate and unrelated to Commonwealth.