401(k), IRA, or Brokerage? How to Choose Your Retirement Savings Account

Saving for the future can feel confusing, but it doesn’t have to be. You might have heard about 401(k) accounts, IRAs, and brokerage accounts. These are different ways to save money for retirement. In this simple guide, we will explain each one and help you understand which might be best for you. We’ll use easy words and examples so that it all makes sense.

What is a 401(k)?

A 401(k) is a retirement savings account you get through a job. It’s named after a section of the tax law (you don’t need to remember that part). Here’s what makes a 401(k) special:

• Offered by Your Employer: You can only have a 401(k) if your employer (the company you work for) offers it. Not all jobs have one.

• Pre-Tax Money: Money you put into a 401(k) comes out of your paycheck before taxes. This means you don’t pay income tax on that money now. Instead, you will pay taxes when you take the money out in retirement.

• Contribution Limits: There is a limit to how much you can put in each year. As of the most recent IRS rules, you can put in $23,000 per year into your 401(k) if you are under 50 years old. If you are 50 or older, you can add a little more (around $7,500 extra) each year to help catch up for retirement.

• Employer Match (Free Money): Many employers will match some of your contributions. For example, your company might add 50 cents for every dollar you put in, up to a certain amount. This is like free extra money for your retirement, just for saving in your 401(k)! It’s a big benefit of using a 401(k).

• When You Can Use It: A 401(k) is meant for retirement. You usually can’t take the money out until you’re about 59½ years old without paying a penalty (an extra fee). There are some special exceptions, but in general, it’s money for later.

What is an IRA?

IRA stands for Individual Retirement Account. It’s another type of retirement savings account, but you open it yourself through a bank or investment company (it’s not tied to one employer). Here are key points about IRAs:

• You Open It: Anyone with earned money (like a salary from a job) can open an IRA. It’s not provided by your employer – you choose to start it on your own.

• Tax Benefits: IRAs also have special tax benefits, and there are two main types:

  • Traditional IRA: Works a lot like a 401(k). You might get a tax break now on the money you put in (meaning you may not pay tax on your contributions this year). You will pay taxes when you withdraw the money in retirement.

  • Roth IRA: The opposite of a Traditional IRA. You put in money that you’ve already paid tax on (after-tax money). The big benefit is that when you take it out in retirement, you won’t have to pay taxes on it — not even on the money it earned, as long as you follow the rules.

• Contribution Limits: There’s a yearly limit on how much you can put into IRAs. Right now, you can save up to $7,000 per year total in your IRAs if you are under 50. If you’re 50 or older, you can put in an extra $1,000 per year. (This limit is smaller than the 401(k) limit.)

• No Employer Match: IRAs are individual accounts, so there is no employer match. It’s all money you decide to save.

• When You Can Use It: Like a 401(k), IRAs are meant for retirement. You generally shouldn’t take money out before age 59½, or you might have to pay a penalty. (One cool thing: with a Roth IRA, you can take out the money you put in at any time without a penalty, because you already paid tax on it. But to keep it simple, both types are best left untouched until retirement.)

What is a Brokerage Account?

A brokerage account is a regular investment account. It’s not specifically for retirement, but you can use it to invest money for any goal, including retirement. Here’s what to know about brokerage accounts:

• No Special Tax Break: Money in a brokerage account is just your own money that you’ve already paid taxes on (your take-home pay). When you invest it, you don’t get a tax break up front like with a 401(k) or an IRA. Also, if your investments earn money (for example, if you sell a stock for a profit or earn interest or dividends on investments), you may have to pay taxes on that money.

• No Contribution Limit: There is no limit to how much you can put into a brokerage account each year. You can invest as little or as much as you want.

• No Employer Involvement: You open this account yourself at a brokerage firm or bank. There is no employer match because it’s not through an employer.

• Flexible Access: You can buy or sell investments in this account at any time. If you need the money, you can take it out whenever you want. There’s no early withdrawal penalty because the account doesn’t have special tax rules for retirement. (Keep in mind, if you made a profit on your investments, you might owe some tax when you sell and take the money out, but that’s just normal tax, not a penalty.)

• Good for Extra Investing: Brokerage accounts are great for goals that are not retirement or for extra investing after you’ve used your accounts with special tax benefits (401(k) or IRA). They give you a lot of freedom, but without the specific retirement tax perks.

Which Account Should You Choose?

Choosing between a 401(k), an IRA, and a brokerage account depends on your situation. Some people even use more than one. Here’s a simple way to decide:

1. If You Have a 401(k) with Employer Match: This is often the first choice. Try to contribute enough to get the full employer match if you can. The match is free money that helps your savings grow faster.

2. Max Out Tax-Advantaged Accounts Next: If you can save more after getting the match, consider putting money into an IRA. Many people choose a Roth IRA for its future tax-free withdrawals, but a Traditional IRA is good if you want a tax break now. You can contribute up to the IRA limit each year.

3. Use a Brokerage Account for Extra Savings: If you still have money you want to invest after using your 401(k) and IRA (or if you want more flexibility), you can put it in a brokerage account. There’s no contribution limit, and you can invest in a wide range of things. Just remember you’ll pay taxes on any profits along the way.

4. No 401(k) at Work? Start with an IRA: If your job doesn’t offer a 401(k), begin with an IRA for retirement savings. An IRA gives you tax benefits for your retirement money. You can also invest in a brokerage account for any money over the IRA limit or for goals where you might need the money sooner.

5. Think About Your Goals: All these accounts can help you save, but they have different benefits. Consider what matters most to you:

   • If you want to avoid taxes on your savings now (and don’t mind paying taxes later in retirement), a 401(k) or Traditional IRA might be the best choice.

   • If you want to pay taxes now and enjoy tax-free money in retirement, a Roth IRA is a great option.

   • If you need flexibility or want to invest more than the other accounts allow, a brokerage account makes sense.

   • Sometimes using a mix of accounts (for example, contributing to both a 401(k) and a Roth IRA) can be a smart way to get the best of both worlds.

Keep It Simple and Start Saving: The most important thing is to start saving early, even if it’s a small amount. Over time, your money can grow through investments. 401(k)s, IRAs, and brokerage accounts are just tools to help your money grow. You don’t have to be an expert to use them. Begin with one that fits you best right now. You can always adjust as you learn more or as your situation changes. Saving for retirement is a journey, and each step you take now will help you in the future. You’ve got this!