401(k) vs. IRA | Which One Should I Choose?

Posted by Shaun Morgan in RetirementNovember 18, 2021(Last Updated July 17, 2022)5 min read
Key Takeaways
  • Having a retirement account helps you financially prepare for your future after leaving the workforce.
  • Of the many retirement plans to choose from, an Individual Retirement Account (IRA) and 401(k) are among the top choices.
  • Although an IRA and a 401(k) serve the same purpose of helping you financially prepare for retirement, they each have different investment options and outcomes.
Are you ready to make some real money moves?

While actively in the workforce, you bring in a paycheck, usually biweekly or monthly. Those funds from your paycheck typically pay your bills and afford you your needs, like shelter and clothing, and your wants, like vacations and gifts. However, there will come a time when you hit retirement age, which means you will no longer have an active paycheck coming in from your employer. But, just because you have retired, you will still need money to pay bills, buy necessities, and hopefully enjoy retirement life.


To avoid financial stress and sustain yourself financially after you have retired, it is best to have a retirement plan in place as early as possible.


Two of the most notable retirement plans are a 401(k) and an IRA. Many people choose a 401(k) because your Human Resource (HR) department at your job can do most of the work for you. On the other hand, an IRA may be best for others who already have a brokerage account. However, no matter which one you choose, make sure it best fits you in the long run.


Preparing for retirement
Image Credit: Khongtham / Shutterstock.com

Most notably, having a retirement account is always better than not having one. So if you are stuck on which option to choose, 401(k) versus IRA, keep reading to determine which retirement plan could be the best route for you. 


The Different Types of Retirement Accounts


Before we get into the different benefits of a 401(k) and an IRA, you should know that the 401(k) and the IRA aren't your only choices. For example, if you are a public or non-profit employee, you should consider a 403b or a 457b for retirement contributions. 

There are also Roth options that you may consider. A Roth IRA, for example, allows you to invest your after-tax dollars into a retirement account. In addition, all earnings in your Roth IRA can be withdrawn tax-free once you are retirement age.

Investing in a Health Savings Account (HSA) is also available. An HSA allows you to contribute to this account for eligible medical expenses. In addition, all contributions to an HSA are tax-deductible. Therefore, if you choose to invest the money in your HSA, your earnings will also be tax-free. 

With so many options, it is important to do your research before picking a retirement account. 


Is a 401(k) or an IRA Best for Me?


Now that we have established that there are numerous retirement plan options, we want to focus strictly on the difference and benefits of the 401(k) and the IRA. In many cases, these are the best options, so don't feel bad if you were unable to or chose not to invest in any of the other options.


Most people consider only two things when choosing between a 401(k) and an IRA. First, they consider the contribution limits, which are substantially higher for a 401(k). Second, they take into account whether or not they are eligible for a 401(k). For example, the 401(k) is an employer-sponsored investment plan, so if you're an independent contractor, you won't have the option to contribute to a 401(k). 


Recommended Read: How To Save For Retirement When You're Self-Employed


When you are considering whether to invest in a 401(k) or an IRA, there are three questions you should ask before making your decision.


Can You Get an Employer Match?


An employer match is free money. So if you have the option, you should take it, and this is why. 


The whole point of investing is to get a return on your investment. That is, you are trying to get a percentage of the money you put in back regularly. However, instead of hoping to get a percentage of return on your investment after a year or more, you are getting an immediate return on your investment in the form of the employer match. In other words, the employer match is almost always the best investment option. 


The employer match is only available through a 401(k) since it is an employer-sponsored plan. 


Recommended Read: How To Plan for Retirement in Your 20's and 30's Using Your 401k Plan

 Weighing the benefits of a 401(k) and IRA

Image Credit: Andrey_Popov / Shutterstock.com


What Investment Options Exist in Each Plan?


Not all retirement plans are created equal. Sadly, some investment companies have predatory practices and sell terrible investment options only to maximize their profits. There are two ways that they do this.


The first predatory practice to look out for is their investment options. Many of these companies sell products that line their pockets and give the investor marginal returns. Therefore, the returns are what you should focus on for this particular question. 


Each investment fund offered will have a prospectus. In that prospectus, it will tell you the historical returns for that fund. The long-term average for the US stock market is around 10%, so if you aren't seeing a historical return that is 10% or higher, run away from those funds. 


Be careful of various annuity options. An annuity is an insurance product that can give you a steady payout of a certain amount each month for the rest of your life after a certain age. However, the bet the insurance company is making is that you won't get the full payout, which makes them money. Not saying you should never get an annuity, but they are something to look out for when deciding on the best investment plan. 


Once you die, whether one month or 30 years after your payouts have started, the payments stop—no money for your heirs. So when considering what plans that pushy salesman is offering at your benefits meeting, make sure you know whether it is an annuity or a regular investment fund. 


What are the Fees for Each Plan? 


The second predatory practice is high fees. Fees are the secret killer of all retirement plans, as these fees generally range from 0.015% to 2% on an annual basis. 

You might look at that and think, so what? It is just 2%. But, the difference between 0.015% and 2% on $100,000 invested is $15 vs. $2,000 out of your pocket every year. So, when considering the funds available in your 401(k), the first question to ask is, what are the fees? 

401(k) plans are notorious for having high fees because the funds available to an employee depend on what fees have been "sold" to your employer. If your employer isn't a savvy investor, then you could lose much of your hard-earned retirement to high-fee funds. In that case, an IRA would be a much better choice because lower fee funds are usually available. 


Recommended Read: How to Choose a Suitable IRA Account


Why Not Invest in Both? 


Most people don't realize that you can contribute to both a 401(k) and an IRA. So, if it makes sense to get the employer match from the 401(k), but you have slightly better fund options in an IRA, you can contribute only the match to the 401(k) and the rest of your contribution to the IRA. 

Another option would be to max out both. The key is to weigh the pros and cons of each plan available to you and build your retirement investment plan from there.




Main Image Credit: Shutterstock.com

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