There is a cornucopia of choices available to people who want to save for retirement. However, the 401(k) plan and the Individual Retirement Account (IRA) are the two most common. Both are solid choices, and there’s some overlap in how they work and the rules investors must follow to use them properly.
However, there are some distinct differences between a 401(k) and a traditional IRA, and three of those differences make the 401(k) the optimal choice (in my humble opinion) for most people.
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Your investing success ultimately depends on three variables: how much you invest, how fast it grows, and how long you can let your portfolio’s growth compound.
Whenever you contribute to a 401(k) or IRA, the income tax you would owe on that money is deferred until you withdraw it in retirement. The IRS limits how much you can put in these plans annually, so people can only reduce their taxable income by so much in a given year.
Arguably, a 401(k) plan’s most significant advantage over the IRA is that you can contribute far more to it.
In 2024, individuals can contribute up to $23,000 to their 401(k), which will increase to $23,500 in 2025. For IRAs, individuals can only contribute up to $7,000, which will not increase in 2025.
But it’s a far wider gap than it looks like. Many employer 401(k) plans offer a 401(k) match to help workers save. The IRS leaves tons of room to fit these additional funds. The total contribution limit for individuals in 2024 is a whopping $69,000.
But wait, there’s more — and older workers will appreciate this one. Once you turn 50, you’re allowed to contribute an additional $7,500, and starting in 2025, this “catch-up” increases to $11,250 for those aged 60, 61, 62, and 63. Meanwhile, the IRA allows an additional $1,000 in annual contributions for those 50 or older.
As mentioned above, many employers offer to match some of your contributions to their 401(k) plans to encourage people to save for retirement. For every dollar you set aside, they will contribute on either a dollar-for-dollar basis or a stated fraction, up to a certain fraction of your salary or a set cap. A typical match is dollar-for-dollar up to 3%. So, if you make $100,000 and route 3% of your salary into your 401(k), your annual contributions will total $6,000 — $3,000 from you and $3,000 from your employer.
This money generally has no strings attached other than a vesting period to encourage employees to stay at the company. A company match is an easy way to boost your total savings, and as a benefit, it’s unique to 401(k) plans.
