401(k) and IRA: The Tax Advantages You're Probably Leaving Behind

A 401(k) and an IRA are not investments. They're containers. The container has special tax rules that let your investments grow faster than they would in a regular brokerage account. Most people leave large amounts of money on the table by not using them correctly.

The 401(k): Employer Match Is Free Money

A 401(k) is a retirement account offered by employers. You contribute pre-tax dollars from your paycheck, they grow tax-deferred, and you pay income tax when you withdraw in retirement.

Many employers match a percentage of contributions (typically 3-6% of salary). If your employer matches 50% of your contributions up to 6% of your salary, and you earn $60,000, that's $1,800 of free money per year just for contributing $3,600 of your own. That's an immediate 50% return before the market does anything.

The rule: Always contribute at least enough to get the full employer match before doing anything else with your money. No investment beats a 50% or 100% immediate return.

Traditional vs. Roth: The Tax Timing Decision

Both 401(k)s and IRAs come in two tax flavors:

• Traditional: Contributions are pre-tax (reduce your taxable income now). You pay income tax on withdrawals in retirement.
• Roth: Contributions are after-tax (no deduction now). Withdrawals in retirement are 100% tax-free, including all the growth.

Which is better depends on whether your tax rate is higher now or in retirement. General guidance:

• Early career, lower income: Roth tends to win. Pay taxes at a low rate now, get tax-free growth for decades.
• Peak earning years, high bracket: Traditional often wins. Take the deduction now at a high rate, pay lower taxes in retirement.
• Uncertain: contributing to both hedges the bet and gives you flexibility later.

IRA and 401(k) Contribution Limits (2024)

• 401(k): $23,000/year ($30,500 if age 50+)
• IRA (Individual Retirement Account): $7,000/year ($8,000 if age 50+)

IRAs are opened by you, independently of your employer. Fidelity, Vanguard, and Schwab all offer no-fee IRAs with no account minimums. Roth IRA eligibility phases out above certain income levels. Check IRS.gov for current thresholds, as they adjust annually.

The Order of Operations

1. Contribute to 401(k) up to the full employer match
2. Build your emergency fund if you haven't already
3. Max out a Roth or Traditional IRA ($7,000/year)
4. Return to 401(k) and increase contributions toward the $23,000 max
5. Taxable brokerage account for anything beyond that

The best retirement account is the one you start funding today, not the one you plan to open when you have more money.