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401ks vs. IRAs: 5 key differences explained

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Key takeaways

  • Both 401ks and IRAs are retirement accounts with special tax advantages, but they tend to be used for different purposes. People frequently have both at the same time.
  • 401ks are offered by your employer and are a great way to save since money gets automatically contributed from your paycheck. Sometimes employers will match these contributions.
  • IRAs play an important role when people leave companies—they are commonly used to transfer (or “roll over”) previous savings into. An IRA is an account you can open and maintain on your own.
  • Put differently, most people choose to save money in an employer-sponsored 401k but then roll over those savings into an IRA when they change jobs.
 401kIRA
What’s it best for?Contributing a portion of your paycheck when you’re employed by a company.Transferring (rolling over) your 401k savings into when you change jobs.
Who provides it?Your employerYou open one on your own
Can I contribute part of my paycheck into it?YesYes
Does it have tax benefits for contributions?YesYes
Can I use it for rollovers?Not always—depends on the 401k plan and employerYes
Are rollovers tax-free?Generally yesGenerally yes
Who chooses the financial institution my account is at?Your employerYou do

You’ve likely heard of both 401ks and IRAs. Although most people are more familiar with 401ks, there’s actually more money now held in IRAs than 401ks—$11 trillion vs $6 trillion, according to the latest data from the Investment Company Institute.

That doesn’t mean IRAs are better or worse. Ultimately, 401ks and IRAs are both retirement accounts that help you save for retirement. They’re just used for different purposes, and it’s common for people to have more than one as they move throughout their career.

We’ll start this article by explaining the five key differences between 401ks and IRAs, and then we’ll answer some common questions about them.

1. 401ks are provided by your employer while IRAs are opened by individuals.

  • A 401k account is a benefit that’s offered by companies. For this reason it’s often referred to as an “employer-sponsored” account. According to the BLS, about 64% of American workers have access to a retirement account like a 401k through their company. They tend to be more common among larger companies than smaller businesses.
  • The employer chooses a financial institution to offer 401k accounts to their employees. This is known as a 401k provider. You’ll recognize many of the largest providers—large financial institutions like Fidelity and also payroll providers like Paychex.
  • An IRA is short for “Individual Retirement Account.” As the name suggests, it’s an account that’s opened and maintained by individuals. IRAs are offered by a wide range of financial institutions, from banks like Chase and Wells Fargo to investment companies like Vanguard and Fidelity. They’re also offered by newer digital-first, “fintech” companies like Betterment and SoFi. Financial institutions offering IRAs are often referred to as “IRA providers” when discussing retirement account transactions.
 

2. 401ks are more commonly used for contributions.

  • Savings that are put into a retirement account are often referred to as “contributions.” You can make contributions to both 401ks and IRAs, so there’s no difference there.
  • Contributions made to these accounts also receive the same tax advantages. If the IRA or 401k is a “traditional” account, then your contributions are made on a pre-tax basis. That money then accumulates over time, and you’ll pay tax on it when you withdraw it. The opposite is true if you have what’s known as a “Roth” account—that’s when contributions are made after tax but then get to be withdrawn tax-free in retirement.
  • While you can contribute to both, most people prefer to make their actual retirement contributions to a 401k rather than an IRA for a few key reasons:
    • 401k contributions are automatic. Your employer usually helps you connect your 401k to your paycheck. This means money is automatically diverted to your 401k account on your behalf. According to a recent Vanguard study, almost 50% of employers will also just automatically enroll you in a 401k when you join.
    • 401ks have higher pre-tax contribution limits. Although there are some exceptions, the IRS allows you to contribute up to $19,500 pre-tax into your 401k each year but only $6,000 into your IRA. Importantly, there’s no limit on the amount you can rollover (rollovers are not the same as contributions).
    • Some companies offer 401k matches, though not all. While most of the money that gets saved in 401ks comes from the individual, some companies will offer to “match” your contribution as a perk.
  • For those who are self-employed or don’t have access to a 401k, IRAs tend to be a good way to put away money for retirement in the same way you would with a company-provided 401k.
 

3. IRAs are more commonly used for “rollovers” (transferring money into).

  • One of the challenges with 401ks is that they are tied to jobs. This means when people change jobs, they need to make a decision on what to do with their savings. According to the BLS, the average employee will change jobs 12 times in their life, so this decision comes up frequently.
  • Generally the four key options are: cash out the money, leave it behind, or transfer it into a new account (that’s known as a “rollover”).
    • Rollovers can be done into both 401ks and IRAs, but more people favor rolling over into an IRA. According to the IRS, there’s almost 5 million rollovers into IRAs per year, and almost $500bn is rolled over from 401ks into IRAs. That compares to an estimated 1.5-2.25mm rollovers into 401ks each year.
  • IRAs tend to be the preferred vehicle for rollover for a few key reasons:
    • Not tied to employer. Since an IRA is opened by an individual, it’s completely separate from an employer. This can make it easy to keep track of over time. In fact, according to the ICI, the number one reason for people using IRAs for rollovers is that they don’t like to leave money tied to former employers.
    • Freedom to choose the institution. While a 401k provider is selected by the employer, the IRA can be opened at any institution you want, including a bnk or brokerage where you have an existing relationship.
    • More administrative challenges rolling into a 401k. According to the GAO, rollovers into 401ks can be more time-consuming and involve more administrative work. Not at 401k plans will even allow new employees to roll over legacy assets. These factors make IRA rollovers an easier and faster choice, especially given that IRA providers often offer assistance to plan participants when they roll their savings into an IRA (GAO, 2013).
 

4. IRAs generally have more investment options.

  • An employer who sponsors a 401k plan usually determines what investments are included in it. They can do this with the guidance of the 401k provider but ultimately the company bears legal responsibility for making these decisions (a type of “fiduciary duty” under the main legislation governing retirement plans, ERISA). On average, a large 401k plan has 20-30 investment options in it, according to the ICI.
  • But an IRA can generally offer much more investment choice. If you open one up at an online broker, you’re generally free to invest in any stocks or ETFs that are available. Some IRA providers will also help you invest in alternative assets, like real estate and crowdfunding.
  • This doesn’t mean IRAs are only for those who want to put their money into a wide range of investments. You can also have your IRA managed for you by a “roboadvisor” or simply pick the investment options that were in your 401k.
 

5. You have more control over fees in your IRA than your 401k. 

  • Investment fees have been a controversial topic in recent years. Thankfully, fees have been coming down in most account types due to technology, competition, and regulatory oversight.
  • That said, you have little control over the fees in your 401k. That’s because they are dependent on your company’s relationship with the 401k provider they’ve chosen. 401k providers charge a range of fees from administrative fees to advisory fees. Some of these can be paid by you and others paid by the company.
  • There’s wide variation in fees in 401k plans. Fees can range from 0.37% for the largest plans to 1.42% for the smallest plans. Unfortunately the exact fee level you’ll pay is largely dependent on your employer’s plan and what they’ve negotiated with the 401k provider. You have very little control.
  • On the other hand, you can exert more control over the fees in your IRA. That’s because you get to choose where you open your account and can clearly see the fees ahead of time. 
    • For automated accounts: these are accounts that create a portfolio for you and manage it. Advisory fees tend to range from 0-0.30%, before taking into the cost of any mutual funds or exchange-traded funds (ETFs) in your portfolio.
    • For self-directed accounts: these are accounts where you pick your own investments. Competition in the sector has driven trading commissions to zero at most large institutions. You still might pay fees on the investment products you purchase (e.g. ETFs), but you’ll likely pay very little or nothing in the way of transaction fees.

1. Can I have both a 401k and an IRA?

Yes. A very common situation is for someone to have a 401k at work, and then an IRA at a financial institution of their choice. That IRA might stay with them throughout their career, and they use it to transfer any 401k funds from jobs they leave.

2. Can I rollover into a 401k, not just an IRA?

It depends on the employer and their 401k plan. Theoretically, rollovers into 401ks are permissible tax-free transactions just like rollovers into IRAs. However not all 401k plans will allow new employees to transfer in legacy 401ks or they may have waiting periods and/or additional administrative work. But rolling over into a 401k can still be a great option.

3. Can I have my 401k or IRA managed for me?

In the case of an IRA, yes, you can pick an “automated” or “roboadvisor” account where an investment portfolio is created and managed for you. These accounts are offered by large institutions like Fidelity, Schwab and E*TRADE as well as fintech companies like Betterment and Wealthfront.

In the case of a 401k, it will depend on your 401k provider. Some 401k plans will have a “managed account” option where your account is invested on your behalf. But much of the time you’re on your own to make decisions on your 401k.

Both 401ks and IRAs are useful account types that help you accumulate money for retirement in a tax-efficient way. They aren’t mutually exclusive—it’s not an “either-or” decision. 401ks tend to be more effective to actually put fresh money into while you’re working at an employer, whereas IRAs tend to be more popular for rollovers (or transferring that money into when you leave). Ultimately a sensible use of retirement accounts will often involve both of them as you move from job to job throughout your career.

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