Pros, cons, & differences in investing in 401k vs. IRA?

Question

What are some of the pros, cons, and differences of investing in a 401k vs. investing in an IRA (either Roth IRA or regular)?

Answer 1

Pro 401K:
- Your employer will often match some % of your contributions - You can contribute almost 4x as much per year to a 401k compared to an IRA. *
- Contributions comes out of your paycheck before you see it, so you are more likely to fund it even if you aren't a disciplined saver.
- Although I don't advise it, you can borrow from your 401k for certain types of expenses. Not true with an IRA.

*Unless you happen to be considered an HCE (Highly Compensated Employee) then it gets tricky.

PRO IRA (Traditional):
- 401K accounts tend to have much higher fees baked into the investments.
- You can contribute money from any source up to the limit, 401k has to come out of your paycheck.
- With an IRA your investment options are much more expansive than the short list of funds the company usually provided in a 401K plan.

PRO ROTH (Both IRA/401K):
- You pay the taxes now on the money you invest, and not on the much higher principal (and likely higher tax rate when you withdraw it)

Answer 2

Someone else has explained the basics. Here's one more difference:

If you're in the 401(k) your company offers, they're probably going to have a limited selection of investments, and fees will eat into your returns. If you put money in an IRA, you can choose from a wide variety of providers and brokerages, and generally invest it in a lot more things (including individual stocks, bonds, options, futures, ETFs, and a wider variety of mutual funds). Most will charge commissions up-front to trade instead ($7-$10 or so is typical) but this is a one-time expense.

The ongoing fees can be a big deal. For instance, a typical small-cap fund from Fidelity (FSLCX) has an expense ratio of 1.25%. The Vanguard small-cap ETF (VB) has an expense ratio of 0.14%. If your company's 401(k) provider is Fidelity, though, you're stuck with the former. Those fees are based on your principal, too: the more money you have just sitting around, the more important this will be for you. Now, the two funds won't have exactly the same performance, but they're likely to be fairly similar. (And for reference, 1.25% is enough of a return to almost double your money in about 45 years.)

If you're only contributing a few hundred a month, the 401(k) is probably cheaper in the short term because you can avoid trading fees. If you're changing jobs, though, consider rolling over your old 401(k) account into an IRA instead of leaving it in place or moving it into your new plan.