Retirement accounts have confusing names and different rules, and nobody explains them in a way that sticks. The 401(k), Traditional IRA, and Roth IRA are the three you’ll encounter most. Each has different tax treatment, contribution limits, and withdrawal rules. Here’s what actually matters about each one.
The 401(k): your employer’s plan
A 401(k) is a retirement account offered through your employer. You contribute money directly from your paycheck before taxes are taken out. If you earn $60,000 and contribute $6,000 to your 401(k), you only pay income tax on $54,000. The $6,000 goes in pre-tax and grows tax-deferred.
You pay taxes when you withdraw the money in retirement (after age 59 and a half). The idea is that you’ll be in a lower tax bracket then than you are now. Maybe that’s true. Maybe it isn’t. Nobody can predict their future tax bracket with certainty.
Contribution limit (2025): $23,500 per year if you’re under 50. $31,000 if you’re 50 or older (the extra $7,500 is a “catch-up” contribution).
Employer match: Many employers match a percentage of your contribution. Common structures include dollar-for-dollar up to 3% of salary, or 50 cents per dollar up to 6%. On a $60,000 salary with a 3% match, that’s $1,800 in free money per year. Not contributing enough to capture the full match is one of the most common and costly financial mistakes working adults make.
Investment options: Your employer selects the investment menu, which typically includes a mix of index funds, target-date funds, bond funds, and sometimes company stock. The quality varies widely. Some 401(k) plans have great low-cost index fund options. Others are loaded with high-fee actively managed funds. Check the expense ratios and choose the lowest-cost options available.
Withdrawal rules: Take money out before 59 and a half and you’ll owe income taxes plus a 10% early withdrawal penalty. There are exceptions (hardship withdrawals, certain medical expenses, first-time home purchases up to a limit), but the rules are strict. Required minimum distributions (RMDs) start at age 73.
The Traditional IRA: the DIY pre-tax option
A Traditional IRA works similarly to a 401(k) in that contributions may be tax-deductible and growth is tax-deferred. You open it yourself at a brokerage (Fidelity, Schwab, Vanguard, etc.) and choose your own investments. No employer involvement required.
Contribution limit (2025): $7,000 per year ($8,000 if you’re 50+). This limit is lower than a 401(k), so it works as a supplement, not a replacement.
Tax deduction: Whether your contribution is tax-deductible depends on your income and whether you have a workplace retirement plan. If you don’t have a 401(k) through work, the full contribution is deductible regardless of income. If you do have a 401(k), the deduction phases out at higher income levels.
Investment options: You can invest in anything your brokerage offers: individual stocks, ETFs, mutual funds, bonds, CDs. This is a major advantage over most 401(k) plans, which limit your choices to whatever’s on the menu.
Withdrawal rules: Same as a 401(k). Taxes and a 10% penalty before 59 and a half. RMDs start at 73.
The Roth IRA: pay taxes now, withdraw free later
A Roth IRA flips the tax treatment. You contribute money you’ve already paid income taxes on. No upfront tax deduction. But the money grows tax-free, and qualified withdrawals in retirement are completely tax-free. No taxes on the growth. No taxes on the withdrawals.
If you contribute $7,000 to a Roth IRA at age 25 and it grows to $70,000 by the time you’re 65, you pay zero taxes on the $63,000 in growth. With a Traditional IRA, that entire $70,000 would be taxed as income when you withdraw it.
Contribution limit (2025): $7,000 per year ($8,000 if you’re 50+). Same as a Traditional IRA, and it’s a combined limit, meaning you can put $7,000 total across both types, not $7,000 in each.
Income limits: You can contribute the full amount if your modified adjusted gross income is below $150,000 (single) or $236,000 (married filing jointly). Above those thresholds, contribution limits phase out. Above $165,000 (single) or $246,000 (married), you can’t contribute directly at all, though a backdoor Roth conversion is an option.
Withdrawal flexibility: You can withdraw your contributions (not earnings) at any time, for any reason, with no taxes or penalties. This makes the Roth IRA partially function as an emergency fund backstop, though you shouldn’t treat it as one routinely. Earnings can be withdrawn tax-free and penalty-free after age 59 and a half, provided the account has been open for at least five years.
No RMDs: Unlike a Traditional IRA and 401(k), the Roth IRA has no required minimum distributions. Your money can grow tax-free for as long as you want, and you can pass the entire account to heirs.
Which account should you use?
The decision framework is simpler than it seems:
Start with the 401(k) match. Contribute at least enough to get the full employer match. This is non-negotiable. A 100% return on day one beats any other investment.
Then fund a Roth IRA (if eligible). If you’re in a low to moderate tax bracket now, the Roth is usually the better choice because you’re locking in a low tax rate on money that will grow for decades. Young workers especially benefit because their current tax rate is almost certainly lower than their future rate.
Then go back to the 401(k). If you’ve maxed the Roth IRA and still have money to invest, increase your 401(k) contributions up to the annual limit.
If you earn too much for a Roth: Max out the 401(k) first, then consider a backdoor Roth IRA (contribute to a non-deductible Traditional IRA, then convert to Roth).
The simplest possible approach
If all of this feels like too much, do this: contribute enough to your 401(k) to get the full employer match, then open a Roth IRA at Fidelity or Vanguard and invest in a target-date fund matching your expected retirement year. Set up automatic monthly contributions and forget about it. You’re now ahead of the majority of Americans in retirement preparedness, and it took maybe an hour to set up.