401k or IRA: Which One Should You Invest in First?

Confused about whether to invest in a traditional or a Roth retirement account? Laura answers a listener question that will help you understand the rules and prioritize contributions among different types of retirement accounts.

Laura Adams, MBA
9-minute read
Episode #441

401k or IRA—Invest in Which One First?Investing through one or more retirement accounts is a smart way to save for your future and cut taxes at the same time. But these special accounts can also be confusing because they come loaded with rules and limitations.

I received a great question from a Money Girl Podcast listener named Sharif Y. He says, “I just graduated college and started my first real job with good pay and a 401k that matches up to 3% of my contributions. So I plan on contributing at least that much to get the free money from my employer. If I can invest more, should it go to the 401k or in a Roth IRA instead?”

In this post, I’ll answer Sharif’s question and help you prioritize contributions among different types of retirement accounts depending on your objectives. Leveraging a variety of options allows you to invest as much as possible and to create more financial security.

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Different Types of Retirement Accounts

Not only are there a variety of retirement accounts for individuals, employees, and the self-employed, but most offer a traditional and a Roth option. Additionally, Roth rules for workplace plans are slightly different than Roth rules for IRAs.

See why I said it’s confusing? Don’t worry, I’ll make it really clear so you know exactly what to do by the end of this post.

For a quick review, IRA is short for Individual Retirement Arrangement. You own it as an individual and choose your own investments. For 2016, you can contribute up to $5,500 (or $6,500 if you’re over age 50) to a traditional IRA, a Roth IRA, or to a combination of them.  In other words, you could contribute $2,000 to a traditional IRA and $3,500 to a Roth—but not $5,500 to each one.

Retirement plans through work—such as a 401k, 403b, 457, or Thrift Savings Plan (TSP) for government employees—are completely different from IRAs. They’re managed by employers only, offer a set menu of investment options, and require contributions to be deducted out of your paycheck.

Many workplace plans also offer a Roth option. You can even split up contributions between traditional and Roth plans, as long as you don’t exceed the annual limit. For 2016, you can contribute up to $18,000 (or $24,000 if you’re over age 50) to most workplace retirement plans.

Additionally, if you’re self-employed, there are a variety of accounts you can use, such as a solo 401k, SEP IRA, and SIMPLE IRA. However, most of them don’t offer a Roth option.  

See also: 5 Retirement Options When You’re Self-Employed


About the Author

Laura Adams, MBA

Laura Adams received an MBA from the University of Florida. She's an award-winning personal finance author, speaker, and consumer advocate who is a frequent, trusted source for the national media. Money-Smart Solopreneur: A Personal Finance System for Freelancers, Entrepreneurs, and Side-Hustlers is her newest title. Laura's previous book, Debt-Free Blueprint: How to Get Out of Debt and Build a Financial Life You Love, was an Amazon #1 New Release. Do you have a money question? Call the Money Girl listener line at 302-364-0308. Your question could be featured on the show.