401(k) vs. IRA: A Beginner's Guide to Retirement Accounts

Retirement accounts give you tax advantages in exchange for keeping money invested for the long term. Understanding the main types helps you decide where your next dollar should go.

401(k) plans

A 401(k) is offered through your employer. Contributions come straight out of your paycheck. Many employers offer a match, such as 50 cents for every dollar you contribute up to 6% of your salary. Contribution limits are much higher than for IRAs. Investment options are limited to the plan's menu.

Traditional IRA

An individual retirement account you open yourself at a brokerage. Contributions may be tax-deductible depending on your income and whether you have a workplace plan. Investments grow tax-deferred, and withdrawals in retirement are taxed as ordinary income.

Roth IRA

With a Roth IRA, you contribute money you have already paid tax on. In exchange, qualified withdrawals in retirement are tax-free, including all the growth. Income limits apply. Roth accounts are often attractive for younger workers who expect to be in a higher tax bracket later.

Traditional vs. Roth: the core question

The choice mostly comes down to whether you would rather pay taxes now or later. If you expect your tax rate to be higher in retirement, Roth contributions tend to make sense. If you expect it to be lower, traditional contributions may be better. Many people hold both for flexibility.

A common order of priorities

1. Contribute enough to your 401(k) to get the full employer match.
2. Pay off high-interest debt.
3. Fund a Roth or traditional IRA.
4. Increase 401(k) contributions toward the annual limit.
5. Invest additional money in a taxable brokerage account.

Contribution limits and income thresholds change most years. Check the current figures on IRS.gov before contributing.

Next: Sinking Funds: The Simple Way to Stop Being Surprised by Big Expenses