IRA vs. 401(k): Which Is Better?

Saving for retirement is an intimidating prospect. The retirement marketplace offers investors myriad methods to grow their hard-earned money, from precious metals IRAs to brokerage accounts with AI retirement trading bots. Many retirement planning forums debate the merits of an IRA versus a 401(k)—so, which is better? 

With an IRA or 401(k), you can maximize retirement savings and potentially reduce your taxable income through tax-deductible contributions. Earnings within the account typically grow tax-deferred, meaning taxes are not paid until withdrawn in retirement

In this guide, we’ll explore how IRAs and 401(k)s work, examining their differences and answering common retirement investing questions. We’ll also show how Composer’s no-code automated trading platform democratizes investing so you can structure your IRA through Composer.

Let’s begin by defining each of these popular retirement investing options.

IRA definition

An individual retirement account (IRA) is a long-term retirement savings account that lets you contribute earned income and gain specific tax advantages. Initially designed for self-employed people and small businesses, IRAs provide numerous investment options to diversify your retirement savings. You can open an IRA through various financial services companies, including banks, online brokerages, or investment firms. 

IRAs come in four basic types. These include:

Traditional IRAs

Traditional IRAs allow you to make tax-deductible contributions that may reduce your taxable income. Contributions and earnings grow tax-deferred, and the IRS taxes withdrawals at your ordinary income tax bracket.

You can take distributions without a penalty beginning at age 59½. Once you reach age 72 (73 if you turn 72 after Dec. 31, 2022), you must take a required minimum distribution (RMD) each year.

Roth IRAs

Unlike traditional IRAs, Roth IRAs do not accept pre-tax contributions, meaning you pay taxes in the year you make contributions. However, you can withdraw contributions tax-free at any time.

To withdraw earnings with no tax, you must be at least 59½ and have held your account for at least five years. Although Roth IRAs do not have RMDs, you may not contribute to one if you earn above a certain income.

Simplified employee pension (SEP) IRAs

Designed for self-employed people and small business owners, SEP IRAs function similarly to traditional IRAs. However, SEP IRAs offer higher contribution limits and only allow contributions from employers. Employers can contribute up to 25% of an employee’s income or $66,000 ($69,000 for 2024), whichever is less.

To contribute to an SEP IRA, you must be at least 21 years old, have worked for the same employer in three of the last five years, and have earned at least $750 during the current year. 

Savings incentive match plan for employees (SIMPLE) IRAs

Small businesses with 100 employees or fewer can use SIMPLE IRAs. Like SEP IRAs, SIMPLE IRAs offer higher contribution limits than traditional IRAs—$15,000 for 2023 and $16,000 for 2024, plus a $3,500 catch-up for employees over 50. Employers can choose to make 2% non-elective contributions based on the employee’s salary or match employee contributions dollar-for-dollar up to 3% of the employee’s salary.

To participate in a SIMPLE IRA, employees must have earned $5,000 or more in one of the previous two calendar years and at least $5,000 in the current year.

401(k) definition

A 401(k) is an employer-sponsored retirement plan. In a 401(k), employees can contribute funds up to an annual limit and receive matching contributions from their employer. Although 401(k)s typically offer fewer investment options than IRAs, most plans allow you to allocate your investments between select mutual funds and ETFs.

For 2024, employees may contribute up to $23,000 to a 401(k) account. Employees over 50 may make catch-up contributions up to $7,500, meaning total employee contributions cannot exceed $30,500. The IRS capped total contributions at $69,000 for 2024 or $76,500 for employees over 50.

Some employers allow employees to mix and match traditional and Roth 401(k) contributions. These accounts offer the same tax benefits as their IRA counterparts, with traditional 401(k)s allowing tax deductions from contributions and Roth 401(k)s providing tax-free withdrawals. 

What is the difference between an IRA and a 401(k)?

Although IRAs and 401(k)s offer similar tax incentives, they differ in several ways. 

Benefits of an IRA vs. a 401(k)

Before choosing an IRA or 401(k), you should weigh their unique benefits:

Benefits of IRA

• More investment options: IRAs grant access to more investment options than 401(k)s, such as individual stocks, index funds, and options. 

• More control: You can open an IRA with any institution you want, providing greater control over how and where you invest your retirement savings compared to 401(k)s. 

Benefits of 401(k)

• Employer contributions: Unlike IRAs (excluding SEP and SIMPLE IRAs), 401(k)s allow employer contributions, typically ranging from 3% to 5%.

• Higher contribution limits: 401(k)s feature higher contribution limits than traditional and Roth IRAs, enabling you to grow your retirement savings quickly.

Empower your retirement savings with Composer

Composer now allows you to leverage user-friendly automated trading strategies in your retirement account. Unlock active trading in your traditional, Roth, and rollover IRA accounts by signing up today. Existing Composer users who roll over $25,000 or more can earn a $250 bonus. This offer is also available to new users who roll over $50,000 or more.