IRA vs. 401(k): Which retirement plan is right for you?

While there are many ways to build your retirement savings so that you can have the post-career life you imagined, two accounts are designed to help you with this goal: an individual retirement account (IRA) and a 401(k).

Each of these savings plans have unique tax considerations, strengths and limitations. Understanding the IRA vs. 401(k) tradeoffs can help you determine which works best for you and which one will allow you to pursue your retirement goals, such as spending more time with family, supporting your community and donating to charities.

To supercharge your savings even more, you can use both types of accounts. In fact, Thrivent's 2022 Retirement Readiness Survey^* found that among those nearing retirement, 42% intend to rely on a mix of assets such as a 401(k), IRA, personal savings, and Social Security benefits.

Here's what you need to know about an IRA vs. 401(k) when it comes to building a strong savings strategy for your retirement.

IRAs differ from 401(k)s in five ways:

• IRA: You can open an IRA through financial institutions, including banks and brokerage firms.
• 401(k): You only can access a 401(k) through an employer that offers one as a benefit. You then fund it through payroll deductions.

• IRA: You can contribute to an IRA, even if you've retired, however, your spouse must have earned income. This includes wages, salaries, tips, bonuses, commissions and earnings from self-employment.
• 401(k): You must be working at a company to contribute to a 401(k). Some employers allow new hires to enroll in their plan immediately, but others may require employees to wait up to a year to participate.

• IRA: An IRA portfolio can include a variety of investments, like stocks, bonds, mutual funds, certificates of deposit (CDs), real-estate investment trusts (REITs) and money market funds.
• 401(k): Portfolio options for a 401(k) generally are limited to the investments the plan provider chooses. These commonly include mutual funds and company stock. (Some plans do enable investors to access a wider variety of choices through a self-directed brokerage account, however.)

The IRS sets contribution limits for retirement plans each year. And, as an additional boost for people age 50 or older, catch-up contributions are able to made beyond the standard limit.

• 2022 contribution limit: $6,000
• 2022 catch-up limit: $1,000

• 2023 contribution limit: $6,500
• 2023 catch-up limit: $1,000

• 2022 contribution limit: $20,500
• 2022 catch-up limit: $6,500

• 2023 contribution limit: $22,500
• 2023 catch-up limit: $7,500

• IRA: The option to borrow funds is not available.
• 401(k): Some providers allow 401(k) participants to borrow from their plans, though 401(k) loans have pros and cons.

While these are the main differences between the two accounts, the Roth versions of both accounts bring more considerations into the mix.

These popular retirement accounts have the same roots but work differently in these ways:

• A traditional IRA is funded with pretax, or "tax later" dollars. Any taxes you pay are deferred until you begin withdrawals.
• Your contributions are tax deductible if you and your spouse don't participate in an employer-sponsored plan. If either of you does participate in an employer plan, your contributions are tax deductible as long as your income is below certain thresholds.
• This option may be beneficial if you believe you are currently in your peak earning years and believe may be in the same or a lower tax bracket in retirement.

• A Roth IRA is funded by money that you've already paid taxes on—also known as after-tax dollars—so withdrawals are tax-free. 
• While there is no tax deduction for Roth IRAs, your investments grow deferred in the account, and you don't pay income taxes on qualified withdrawals.³
• A Roth IRA may be advantageous if you believe you are not in your peak earning years and think you may be in a higher tax bracket in retirement.

• Traditional IRAs: No income limits to participate, though there are income thresholds for tax-deductible contributions if you or your spouse has an employer plan.¹

• Roth IRAs: There are set income limits to participate². Income limits don't apply if you're converting to a Roth IRA, where you convert a tax-deferred retirement account, such as a traditional IRA or 401(k), into a Roth IRA.

A RMD is the minimum amount of money you must withdraw from a tax-deferred retirement plan after you reach a certain age.

Traditional IRA: RMDs start at age 72. Recent tax legislation will increase the RMD age to 75 over a 10 year period. You pay income taxes on the distributions.

Roth IRA: RMD rules don't apply to Roth IRAs. However, upon the account owner's death, beneficiaries may be required to take an RMD from that account every year or face a penalty.

Traditional IRA: You could be penalized for taking money out before age 59½. Generally, early withdrawals from your IRA before that age are included in your income for the year for tax purposes, plus an additional 10% tax penalty. The IRS has some early withdrawal penalty exceptions.

Roth IRA: You may take withdrawals of your contributions without taxes or penalties. However, early withdrawals of earnings on that money may be subject to taxes and penalties.

For distributions of earnings to be tax-free³, your Roth IRA must be at least five years old and one of the following requirements must be met:

• You're at least age 59½.
• You're disabled.
• You're purchasing your first home ($10,000 lifetime maximum).
• The money is being paid to a beneficiary.

Many employers have begun offering Roth 401(k)s, which differ from traditional plans in a major way. While you contribute pretax dollars through payroll deductions to a traditional 401(k), your contributions to a Roth 401(k) are made with after-tax dollars through payroll deductions.

If you have the option of a Roth 401(k), you can choose to allocate some money to it and some to a traditional 401(k).

If you're fortunate to have an employer that matches some or all of your 401(k) contributions, that money may not be able to be put into a Roth 401(k), so it may have to be allocated to your traditional 401(k) account. You pay taxes on it when you start taking distributions.

Here's how these Roth accounts stack up against each other:

• Roth 401(k): Typically has a limited number of investment options.
• Roth IRA: Can hold many different investments that you choose.

• Roth 401(k): Don't have income limits.
• Roth IRA: Have income limits to participate.²

• 2022 contribution limit: $20,500
• 2022 catch-up limit: $6,500

• 2023 contribution limit: $22,500
• 2023 catch-up limit: $7,500

• 2022 contribution limit: $6,000
• 2022 catch-up limit: $1,000

• 2023 contribution limit: $6,500
• 2023 catch-up limit: $1,000

• Roth 401(k): You must begin taking RMDs at age 72, unless you're still working and aren't a 5% owner of the business sponsoring the plan. However, each employer has the right to offer that delayed distribution option or not.
• Roth IRA: Don't have RMDs, although beneficiaries may need to take them. (This freedom from RMDs is one reason Roth 401(k) owners should consider rolling their account into a Roth IRA before age 72).

• Roth 401(k): You can borrow from a Roth 401(k) account if it's permitted in your plan.
• Roth IRA: You can't borrow from a Roth IRA.

For both a Roth 401(k) and a Roth IRA, withdrawals of contributions and earnings are tax-free and penalty-free if the account is at least five years old and one of the following requirements is met:

• You're at least age 59½.
• You're disabled.
• The money is being paid to a beneficiary.

A Roth 401(k) offers the following advantage:

• You can take a partial distribution that draws from both your contributions and earnings (prorated), unlike a Roth IRA, which draws from your contributions first.

While a Roth IRA has these perks:

• You can have a qualified distribution of up to $10,000 for a first-time home purchase.
• You can take withdrawals of the contributions you made to a Roth IRA without taxes or penalties.

Is an IRA the same as a 401(k)? They are different, but one source of confusion could stem from employer-offered IRAs. One is a Simplified Employee Pension (SEP) plan and the other is a Savings Incentive Match Plan for Employees (SIMPLE).

Employers that offer these accounts, which tend to be small businesses, can contribute to their workers' IRA-based plans.

The answer depends on your financial goals and personal variables, like your age, work status and investment horizon. For example, if you work for a company that offers a 401(k) match, you could earn essentially free money by contributing to a 401(k). Now, if you've changed jobs where you had a 401(k), you may want to consider rolling your account into an IRA.⁴

Remember that both accounts also can work together. Consider funding an IRA if you've maxed out your 401(k) contributions or met your company match but want to save more for retirement. In addition, owning retirement accounts that are taxed differently, like a 401(k) and a Roth IRA, can help diversify your tax liabilities. Just keep in mind that if you or your spouse contributes to a 401(k) and a traditional IRA at the same time, the deduction you can claim on your federal income tax return may be limited.

• 2022 deduction details
• 2023 deduction details

The ins and outs of retirement accounts can be a lot to sort through. For personalized guidance, insight into different savings strategies and setting yourself up for the retirement you've always dreamed of, connect with a financial advisor.