Types of retirement accounts: IRAs and 401(k)s
Deciding to save for retirement now could help you have a more secure future. Figuring out how to do it, on the other hand, can be a bit confusing. How do you determine what’s best for you and your goals?
We can help. By learning about your options, you can choose the type of savings account that’s right for your life, now and in the future.
Let’s start with the two most common ways to save—Individual Retirement Accounts (or IRAs) and 401(k) accounts. We’ll break down the similarities and differences between traditional 401(k)s and traditional IRAs, then share details around Roth IRAs and Roth 401(k)s, giving you a basic understanding of each.
How are IRAs and 401(k)s the same?
- A 401(k) and an IRA are two types of investment accounts that help you save for retirement.
- Both accounts let you make ongoing contributions1 and invest your savings in the market for potential growth over time.
- They also both come with certain tax benefits, but each is a little different.
How are they different?
| Traditional 401(k) | Traditional IRA |
|---|---|
| Employers provide a 401(k) to employees as a benefit | An IRA is an individual retirement account, so it belongs to you individually |
| Lowers your taxable income because most 401(k) contributions are made before taxes are taken out | Your traditional IRA contributions are made from your taxable earnings, you are then permitted to deduct the contributions from your income in certain situations |
| The employer selects the investment options offered in the plan | Typically offers a wider range of investment options than a 401(k) |
| The employer may match up to a certain percentage of your contribution | Isn’t tied to your employer, so you don’t get a match on your contribution—however, you have more control and flexibility when and how you contribute |
| You may be able to roll over an old 401(k) from a previous job into the 401(k) at your current job | You can roll multiple outside accounts like old 401(k)s or other IRAs into one IRA to simplify your savings |
When would you use an IRA vs. a 401(k)?
Consider investing in a 401(k) if:
- You have access to one where you work
- Your employer offers to match a percentage of your contribution
- Looking to invest in a retirement account with more distribution options
You may want to invest in an IRA if you are:
- Wanting a way to save alongside your company 401(k) plan
- Looking to get access to a broader range of investment options
- Transitioning to self-employment
- Looking to simplify tracking and management of your savings by consolidating multiple retirement accounts
What about Roth?
Now that you know more about traditional 401(k)s and traditional IRAs, let’s talk about Roth accounts. Roth 401(k)s and Roth IRAs have slightly different features, specifically taxes. In a Roth account, you pay taxes on your contributions up front, then withdraw your money tax free in retirement.2 Consult with your tax advisor on what’s best for your situation.
Here's a quick comparison of all 4 types of retirement accounts:
| Traditional 401(k)3 | Traditional IRA | Roth 401(k)3 | Roth IRA | |
|---|---|---|---|---|
| When do you pay taxes? | Traditional 401(k) In retirement, when you withdraw your savings | Traditional IRA In retirement, when you withdraw your savings | Roth 401(k) Up front, before you contribute. Your earnings are tax free | Roth IRA Up front, before you contribute. Your distributions are tax free2 |
| Is there an age limit? | Traditional 401(k) You can contribute as long as you're still working | Traditional IRA As long as you are still earning income, you can contribute | Roth 401(k) You can contribute as long as you're still working | Roth IRA As long as you are still earning income, you can contribute |
| How much can you contribute each year? | Traditional 401(k)
| Traditional IRA
| Roth 401(k)
| Roth IRA
|
| Is there an income limit? | Traditional 401(k) You must have earned income, but there’s no maximum limit | Traditional IRA You must have earned income, but there’s no maximum income limit. Review the details. | Roth 401(k) You must have earned income, but there’s no maximum limit | Roth IRA Yes—review the details |
| When can you withdraw your money?6 | Traditional 401(k)
| Traditional IRA
| Roth 401(k)
| Roth IRA
|
| When might it make sense to invest in this type of account? | Traditional 401(k) If your employer offers one, and especially if they offer an employer match | Traditional IRA If you want to save outside of an employer plan account, and you expect you’ll be in a lower tax bracket in retirement | Roth 401(k) If your employer offers one (especially with an employer match) and you think tax rates may be higher when you retire | Roth IRA If you want to save outside of an employer plan account, you think tax rates may be higher when you retire, and your income doesn’t exceed the max limit |
Start saving today
If you’re ready to take the next step toward saving for a more secure retirement, keep the momentum going:
- Have a Principal retirement account from your employer? Log in to check in on your savings. First time logging in? Get started here.
- Think about opening an IRA to give yourself an ongoing way to save for retirement. Learn more about an IRA with Principal.
- Looking to find money to invest? Check out 6 money savings tips.
1 Contribution limits may apply.
2 Your account must be open for 5 years and you must be over age 59½ or meet another qualifying event to be eligible for qualified tax-free withdrawals of earnings.
3 Specific to employee-elected deferrals.
4 2020 contribution limits.
5 May withdraw prior to age 59 ½ but subject to early withdrawal penalties.
6 For the year 2020, taxpayers have the option to not take an RMD from eligible retirement plans and IRAs. Subject to certain limited exceptions provided under the Coronavirus Aid, Relief, and Economic Security (CARES)
This document is intended to be educational in nature and is not intended to be taken as a recommendation.
Investing involves risk, including loss of principal.
The subject matter in this communication is provided with the understanding that Principal® is not rendering legal, accounting or tax advice. You should consult with appropriate counsel or other advisors on all matter pertaining to legal, tax or accounting obligations and requirements.
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