Guides IRA 101

IRA vs. 401(k): How to Choose

Dayana Yochim
April 30, 2018

In a perfect world, you could max out both. Otherwise, first get any 401(k) match you can, then max out your IRA. This can help maximize your returns and minimize your costs.

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The quick answer: IRA vs. 401(k)

Given the choice between putting money in an employer-sponsored retirement account such as a 401(k) or a self-directed savings vehicle like a Roth or traditional IRA, the ideal answer is “all of the above.” But until — or even if — maxing out both is an option, you do want to prioritize your retirement savings dollars according to a general 401(k) versus IRA pecking order.

  • If your employer offers a 401(k) with a company match: Fund your 401(k) up to the point where you get the maximum matching dollars, then consider an IRA. If you max out the IRA for the year, return to the 401(k) and resume contributions there.

  • If your employer doesn't offer a company match: Skip the 401(k) at first and start with an IRA. After contributing up to the limit, fund your 401(k) for the pre-tax benefit it offers.

» Want a personalized recommendation? Get details on your retirement forecast and specific guidance for your situation with a free Nerdwallet account.

A detailed comparison

Want to know more about the differences between these accounts? Here's a deep dive into the 401(k) and both types of IRAs, starting with pros and cons.

Decided how you'll save?

If you have a clear vision for where your savings will live, you can jump to these resources:

For more on striking the right savings balance between a 401(k) and an IRA, read on.

How to max out your retirement accounts in 2018

If you can save enough to max out both your 401(k) and an IRA, your name deserves to be engraved on a Retirement Saver of the Year plaque.

As you rev up your retirement savings engine, let’s look at a detailed IRA versus 401(k) investing road map to guide the decision about which type of retirement account to choose, in what order and to what extent you should contribute.

If your employer offers a 401(k) match

1. Contribute enough to earn the full match. Check your employee benefits handbook. If you see that your employer matches any portion of the money you contribute to the company 401(k) plan, do not pass go without stopping here first to collect your free money.

A company matching program is one of the biggest benefits of a 401(k). It means that your employer contributes money to your account based on the amount of money you save, up to a limit. A common arrangement is for an employer to match a portion of the amount you save up to the first 6% of your gross earnings. (Use our 401(k) calculator to figure out how much your match might be worth.)

Even if your 401(k) has limited investment choices or higher-than-average fees, get the full company match.

Even if a 401(k) has limited investment choices or higher-than-average fees, carve out enough money from your paycheck to get the full company match, aka a guaranteed return on those investment dollars.

Note that employer contributions don't count toward the 401(k) annual contribution limit.

2. Next, contribute as much as you’re allowed to an IRA. Depending on which type of IRA you choose — a Roth or traditional — you can get your tax break now or down the road when you start withdrawing funds for retirement.

  • A traditional IRA is often the preferred choice for those close to retirement age and in a higher tax bracket now than they expect to be when they start making withdrawals. Contributions may be deductible, though if you are also covered by a 401(k), that deduction may be reduced or eliminated based on income. See the IRA contribution limits to determine whether your deduction will be affected.

  • A Roth IRA is a good choice if you’re not eligible to deduct traditional IRA contributions, or if you're in a lower tax bracket now than you think you’ll be in retirement. Roth IRA eligibility is not affected by participation in a 401(k), but it may be affected by your income. See the Roth IRA contribution limits to find out if you're eligible for this account.

» Stuck between the two? Visit our Roth IRA vs. traditional IRA comparison.

3. After maxing out an IRA, revisit your 401(k). Even after you’ve gotten the employer match — and even if your investment choices are limited, which is one of the main drawbacks of workplace retirement plans — a 401(k) is still beneficial.

The money you contribute to a 401(k) will lower your taxable income for the year dollar for dollar. And don’t forget about the added benefit of tax-deferred growth on investment gains, which, if you squint your eyes really hard, can sorta make you believe that you’re getting one over on the IRS. (It’s perfectly legal, so you’re not actually outmaneuvering Uncle Sam, but you can still pretend like you are.)

If your employer doesn't offer a 401(k) match

1. Contribute to an IRA first. Not all companies match even a portion of employee retirement account contributions (boo, hiss). When that’s the case, choosing an IRA — and contributing up to whatever amount IRS rules allow for your situation — is generally a better first option.

Bargain-shop for low-cost index funds and ETFs.

And it’s certainly no consolation prize. One of the biggest benefits of an IRA is that it offers access to a virtually unlimited number and type of investments, giving you much more control over your retirement savings destiny: You can bargain-shop for low-cost index mutual funds and ETFs instead of being restricted to the offerings in a workplace retirement account, and you can avoid paying the administrative fees that many 401(k) plans charge. It’s like the difference between shopping for household necessities at Costco versus an airport kiosk.

2. After maxing out IRA benefits, contribute to your 401(k). Here again, the tax deferral benefit of a company-sponsored plan is a good reason to direct dollars into a 401(k) after you’ve funded an IRA.

Only in the worst cases — a retirement account with truly crummy, high-fee investment choices and high administrative costs — would it be advisable to completely avoid your company plan. Be sure to revisit the rules about combining contributions to a 401(k) and a traditional IRA. If your income passes certain thresholds, your ability to deduct traditional IRA contributions may be reduced or eliminated. If you aren't eligible for a traditional IRA deduction, you may still be eligible for a Roth IRA.

Even if you're not eligible to deduct your traditional IRA contribution, you can make nondeductible contributions and still benefit from tax-deferred investment growth.