Our content is for education only and is not personal financial advice. Some links may earn us a commission at no cost to you, which never affects our recommendations.
Key takeaways
- Contribute enough to your 401(k) to get the full employer match first. It is part of your compensation.
- Next, consider an IRA for more investment choice and potentially lower fees.
- Then return to the 401(k) to use its higher contribution limit.
- Choosing between Roth and traditional depends on whether you expect a higher tax rate now or in retirement.
If you are saving for retirement in the United States, two accounts do most of the heavy lifting: the workplace 401(k) and the individual retirement account (IRA). Both offer valuable tax breaks. The question is not which one is better, but which order to fund them in.
What is a 401(k)?
A 401(k) is a retirement plan offered by an employer. Contributions come straight out of your paycheck, and many employers add a matching contribution. Similar plans include the 403(b) for nonprofits and schools and the 457(b) for some government workers.
What is an IRA?
An IRA is a retirement account you open yourself at a brokerage or bank. Anyone with earned income can generally contribute, subject to income rules for some types. You choose the provider and the investments.
401(k) vs. IRA at a glance
| 401(k) | IRA | |
|---|---|---|
| Who offers it | Your employer | You open it yourself |
| Employer match | Often available | No |
| Contribution limit | Much higher | Lower |
| Investment choice | Limited menu chosen by the plan | Almost any stock, bond or fund |
| Fees | Vary by plan, sometimes high | You can choose low-cost providers |
| Roth option | Many plans offer a Roth 401(k) | Roth IRA, subject to income limits |
A simple order of operations
- Get the full 401(k) match. If your employer matches 50% of the first 6% you contribute, contribute at least 6%. Skipping the match means leaving free money behind.
- Pay off high-interest debt. Credit card interest usually outpaces what investments reliably earn.
- Fund an IRA. You gain more investment choice and can keep fees low. A Roth IRA is popular if you qualify.
- Go back to the 401(k). Increase contributions toward the annual limit.
- Invest in a taxable brokerage account once tax-advantaged space is used up.
Roth or traditional?
Both accounts come in two tax flavors:
- Traditional: contributions may reduce your taxable income today; withdrawals in retirement are taxed as income.
- Roth: you contribute money you have already paid tax on; qualified withdrawals in retirement are tax-free.
As a rule of thumb, Roth tends to make sense if you expect to be in a higher tax bracket later, which is common early in a career. Traditional can make sense in your peak earning years. Many people split contributions between both to hedge their bets.
Are you on track?
Use the calculator below to see how your current contributions could grow and whether you are on pace for the income you want.
Common mistakes
- Not contributing enough to get the full match
- Leaving 401(k) money in the default cash option instead of investing it
- Cashing out a 401(k) when changing jobs instead of rolling it over
- Ignoring fund fees
How an employer match works
An employer match is money your company adds to your 401(k) when you contribute. It is one of the few places in personal finance where you get an instant, guaranteed boost on every dollar you save, which is why capturing the full match is almost always the first step.
Matches are usually described as a percentage of your contributions up to a percentage of your salary. Here is how two common formulas work on an example salary of $60,000:
| Match formula (example) | You contribute | Employer adds | Total going in |
|---|---|---|---|
| 100% of the first 3% of pay | 3% = $1,800 | $1,800 | $3,600 |
| 50% of the first 6% of pay | 6% = $3,600 | $1,800 | $5,400 |
In both cases, contributing less than the threshold means leaving part of the match unclaimed. Check your plan documents or HR portal for your exact formula.
Watch out for vesting
Your own contributions always belong to you. Employer contributions, however, may follow a vesting schedule, which means you earn full ownership of the match gradually over a period of years. If you leave before you are fully vested, you may forfeit some of the employer money. If you are thinking about changing jobs, it is worth checking how close you are to your next vesting milestone.
Traditional vs. Roth in more detail
The choice between traditional and Roth contributions is really a question about when you pay tax: now, or later.
| Traditional 401(k) or IRA | Roth 401(k) or IRA | |
|---|---|---|
| Tax on contributions | Usually reduces taxable income now (IRA deductibility depends on income and workplace plan rules) | No deduction now; you contribute after-tax money |
| Tax on growth | Tax-deferred | Tax-free if rules are met |
| Tax on qualified withdrawals | Taxed as ordinary income | Tax-free |
| Best fit when | You expect a lower tax rate in retirement | You expect a similar or higher tax rate in retirement |
Nobody knows exactly what tax rates will look like decades from now, so many savers use both. Having some money in traditional accounts and some in Roth accounts gives you flexibility to manage your taxable income in retirement, a strategy often called tax diversification.
Roth IRA income limits
Direct contributions to a Roth IRA are phased out above certain income levels, which depend on your tax filing status and are adjusted over time. If your income is too high to contribute directly, some people use a strategy known as a backdoor Roth, which involves contributing to a traditional IRA and converting it. The tax rules around conversions can be complex, so it is wise to review current IRS guidance or talk to a tax professional before trying it.
What if your employer does not offer a 401(k)?
Not having a workplace plan does not mean you cannot save for retirement with tax advantages. You have several options:
- Traditional or Roth IRA. Anyone with earned income can generally contribute, and without a workplace plan, traditional IRA contributions are more likely to be fully deductible.
- Solo 401(k). Self-employed people with no employees other than a spouse can often open one, which allows both employee-style and employer-style contributions.
- SEP IRA. A simple option for self-employed people and small business owners, funded by employer contributions.
- SIMPLE IRA. Some small employers offer this instead of a 401(k), usually with a required employer contribution.
- Taxable brokerage account. Once you have used your tax-advantaged options, a regular investment account offers flexibility with no withdrawal restrictions.
Choosing investments inside your accounts
Opening a retirement account is only half the job. The money needs to be invested, and the choices you make inside the account matter just as much as which account you pick.
- Target-date funds automatically hold a mix of stocks and bonds that becomes more conservative as your chosen retirement year approaches. They are a simple, hands-off option for many savers.
- Broad index funds track large parts of the market at low cost. A mix of a total U.S. stock fund, an international stock fund and a bond fund can form a complete portfolio.
- Fees matter. Look at each fund’s expense ratio. Over decades, even small differences in fees can add up to a noticeable difference in your final balance.
- Check the default. Some plans place new money in a cash or stable value fund by default. Make sure your contributions are actually invested according to your plan.
Withdrawal rules to know
Retirement accounts come with tax benefits in exchange for keeping the money invested until retirement. In general, withdrawing from a 401(k) or IRA before age 59½ can trigger income tax plus an additional early withdrawal penalty, although there are specific exceptions set by the IRS.
- Roth IRA contributions (not earnings) can generally be withdrawn at any time without tax or penalty, which gives Roth IRAs some extra flexibility.
- 401(k) loans may be available in some plans, but borrowing from your future can slow your progress, and leaving your job can make the loan due sooner.
- Required minimum distributions apply to many retirement accounts once you reach a certain age, which has changed in recent law. Check the current rules on IRS.gov as you get closer to retirement.
Treat retirement accounts as long-term money. Keeping a separate emergency fund reduces the temptation to tap them early.
When you change jobs
Leaving an employer does not mean losing your 401(k). You typically have four choices:
- Leave it in your old plan, if the plan allows it.
- Roll it into your new employer’s plan, which keeps things simple.
- Roll it into an IRA, which often gives you more investment choices and control over fees.
- Cash it out, which usually triggers taxes and possibly penalties and should generally be avoided.
If you roll money over, a direct rollover, where the funds move straight from one account to another, helps you avoid tax withholding and deadline problems.
Putting it together at every stage of your career
Early career
Focus on getting the full match and building the habit. Roth contributions are often attractive when your income, and therefore your tax rate, is relatively low. Aim to increase your contribution rate by 1% each year or whenever you get a raise.
Mid-career
As your income grows, consider balancing Roth and traditional contributions, and work toward saving around 15% of your income for retirement, including any match. Review your investment mix and fees at least once a year.
Late career
Use any catch-up contributions available to you, estimate the income you will need, and start planning how you will withdraw money in a tax-efficient way. Speaking with a fee-only financial planner can be especially valuable at this stage.
How to open an IRA in five steps
- Choose where to open it. Most large online brokerages and many robo-advisors offer IRAs. Compare account fees, the range of low-cost funds available and how easy the website or app is to use.
- Pick the type. Decide between a traditional IRA, a Roth IRA or a mix over time, based on your tax situation and eligibility.
- Fill out the application. You will usually need your identification details, your Social Security number or local tax ID, your employment information and a bank account to fund the IRA.
- Fund the account. You can make a one-time contribution, set up automatic monthly transfers or roll over money from an old 401(k). Automatic contributions make saving effortless.
- Invest the money. This step is easy to forget. Cash sitting in an IRA does not grow much. Choose a target-date fund or a simple mix of low-cost index funds so your contributions start working for you.
The whole process often takes less than half an hour online. Once it is set up, check in once or twice a year to confirm your contributions are on track and your investment mix still fits your goals and timeline.
Frequently Asked Questions
Can I have both a 401(k) and an IRA?
Yes. You can contribute to both in the same year. However, if you or your spouse are covered by a workplace plan, your ability to deduct traditional IRA contributions may be limited depending on your income.
How much should I contribute to my 401(k)?
At minimum, contribute enough to receive the full employer match. A common long-term target is to save around 15% of your income for retirement across all accounts, but the right number depends on your age, goals and current savings.
Is a Roth IRA better than a 401(k)?
Neither is better in every case. A 401(k) with a match is usually the first priority. A Roth IRA is a strong next step for its flexibility and tax-free withdrawals in retirement, as long as you are eligible to contribute.
What happens to my 401(k) if I get laid off?
Your contributions and any vested employer money remain yours. You can usually leave the account where it is, roll it into an IRA or roll it into a new employer’s plan later.
Where can I find the current contribution limits?
The IRS publishes the latest 401(k) and IRA contribution limits, catch-up amounts and Roth income limits each year on IRS.gov. Check them before you set your contribution amounts.
The bottom line
Start with the 401(k) match, add an IRA for flexibility and low costs, then max out what you can. The most important step is starting early and increasing contributions over time. Curious about retiring ahead of schedule? Read our guide to the FIRE movement.
If you do only one thing this week, log in to your workplace retirement plan and confirm that you are contributing enough to receive the full match. Then set a reminder to raise your contribution by one percentage point at your next raise. Small, steady increases like these are how ordinary savers build extraordinary retirement balances over time.
Peter Igunnu
Peter Igunnu is the founder and editor of GuideToYourMoney. He holds a PhD in Banking and Finance, with research covering financial inclusion, green finance and AI in finance. He writes to make money decisions simpler for everyday readers.
