Retirement Accounts Compared: 401(k), IRA and Roth IRA

Retirement accounts differ in three dimensions: who contributes, when tax is paid, and how much can go in. Get those three right and the ordering follows almost automatically.

The 401(k)

An employer-sponsored plan funded through payroll. Traditional contributions reduce taxable income now and are taxed on withdrawal in retirement. Many plans also offer a Roth 401(k), where contributions are after-tax and qualified withdrawals are tax-free.

The defining feature is the employer match. A dollar-for-dollar match on the first several percent of salary is an immediate, guaranteed return that no investment can reliably match. Contributing less than the full match is leaving compensation unclaimed.

Watch the plan's fund menu and administrative fees. Some plans offer index funds under 0.05%; others offer expensive actively managed options and little else.

The traditional IRA

An individual account you open yourself, with a much wider investment menu and usually lower costs than a workplace plan. Contributions may be tax-deductible depending on income and whether you are covered by a workplace plan. Growth is tax-deferred; withdrawals are taxed as income.

The Roth IRA

Funded with after-tax money. Qualified withdrawals — including all investment growth — are tax-free. Contributions (not earnings) can generally be withdrawn at any time without penalty, which gives the Roth unusual flexibility.

Income limits apply to direct contributions. Roth accounts are most valuable when you expect your tax rate in retirement to be at least as high as it is now, which is typically true early in a career.

The ordering most people should use

1. Contribute enough to the 401(k) to capture the full employer match.
2. Pay off high-interest debt.
3. Fund a Roth IRA to the annual limit, if eligible.
4. Return to the 401(k) up to the annual limit.
5. Invest additional money in a taxable brokerage account.

Details that catch people out

• Vesting. Employer contributions may require years of service before they are yours.
• Required minimum distributions. Traditional accounts eventually force withdrawals; Roth IRAs do not for the original owner.
• Rollovers. Moving an old 401(k) to an IRA usually cuts costs and expands choice. Use a direct trustee-to-trustee transfer.
• Beneficiaries. These designations override your will. Review after any major life event.

Practical takeaways

• The match is the highest-return decision available; take all of it.
• Choose Roth when you expect higher future tax rates, traditional when lower.
• Roll old workplace plans into an IRA to reduce cost and complexity.