Quick overview

401(k)s and IRAs are both tax-advantaged retirement accounts, but they serve different roles in a household retirement plan. 401(k) plans are workplace plans with higher contribution ceilings and possible employer matching. IRAs are opened by individuals at a bank, brokerage, or other custodian and offer more investment variety and flexible tax choices (traditional vs. Roth).

This article explains the key contribution rules and rollover mechanics, highlights tax traps and practical strategies, and links to deeper FinHelp guides and IRS resources so you can act confidently.

How contributions differ (rules, limits, and tax treatment)

  • Contribution source and sponsorship:

  • 401(k): Sponsored by an employer. Employees elect contributions that are deducted from payroll (pre-tax for traditional 401(k) or after-tax for Roth 401(k) if the plan offers it).

  • IRA: Individual account opened and funded by you. Contributions are made directly to the custodian.

  • Contribution limits and catch-ups:
    Contribution limits are adjusted periodically for inflation and announced by the IRS annually. Because they change, always confirm current limits on the IRS site before planning contributions (see IRS links below). Generally, 401(k) plans allow substantially larger yearly deferrals than IRAs and include higher catch-up contributions for participants aged 50 and over.

  • Tax treatment:

  • Traditional 401(k) and traditional IRA: Contributions may be pre-tax (401(k)) or tax-deductible (IRA) and taxes are paid on withdrawals in retirement. Deductibility of traditional IRA contributions may be limited by participation in an employer plan and by income.

  • Roth 401(k) and Roth IRA: Contributions are made with after-tax dollars; qualified withdrawals are tax-free. Roth IRA eligibility is phased out at higher incomes; Roth 401(k)s don’t have income limits for contributions (but your ability to contribute is still limited by the overall elective deferral cap).

  • Employer match and vesting:
    The single biggest advantage of many 401(k)s is an employer match. Matches are essentially free money; always try to contribute at least enough to capture the full match. Employer-matched funds may be subject to a vesting schedule.

Rollovers: types, tax consequences, and best practices

When you change jobs, retire, or want to consolidate accounts, you’ll encounter several rollover options. Understanding the difference matters for taxes, penalties, and investment flexibility.

  • Direct (trustee-to-trustee) rollover — recommended:
    Your plan administrator moves assets directly to another qualified plan or to an IRA. There is no mandatory withholding and no immediate tax consequence when rolling pre-tax assets to another pre-tax account. Use a direct rollover to avoid accidental taxation.

  • Indirect rollover (60-day rollover) — riskier:
    The plan distributes a check to you. If the distribution is from an employer plan and payable to you, the plan administrator is typically required to withhold 20% for federal income tax. You must deposit the full amount of the distribution (including the withheld 20%) into a rollover IRA within 60 days to avoid taxes and potential penalties; you would need to make up the withheld 20% from other funds to complete the rollover. Missing the 60-day window generally makes the distribution taxable and potentially subject to a 10% early withdrawal penalty if you’re under age 59½.

  • Plan-to-plan rollovers:
    You can generally move money from one employer plan to a new employer’s plan if the receiving plan accepts rollovers. This is often done to preserve loan options or to keep company stock treatment.

  • Rolling to a Roth (conversion) — taxable event:
    Rolling pre-tax 401(k) or traditional IRA assets into a Roth IRA (or Roth 401(k)) triggers income tax on the converted amount in the year of the conversion, because you’re moving money from tax-deferred to after-tax status. Consider staging conversions over years to manage tax brackets.

  • Special cases and exceptions:

  • Rollover of employer stock may have special tax treatment (net unrealized appreciation); confirm with your plan administrator and advisor.

  • Required minimum distributions (RMDs): You cannot roll funds that have already been distributed to satisfy an RMD. Roth IRAs are not subject to RMDs for the original owner; Roth 401(k)s are subject to RMD rules unless rolled into a Roth IRA.

Practical rollover checklist

  1. Confirm your plan’s rollover policy and investment options.
  2. Choose direct rollover (trustee-to-trustee) to avoid withholding.
  3. If you receive an indirect rollover check, deposit the full distribution amount (including taxes withheld) to an IRA within 60 days — or else plan for the tax effect.
  4. Update beneficiaries on the receiving account.
  5. Compare fees, investment choices, and creditor protection when deciding whether to roll to an IRA or leave funds in a 401(k).

Why you might roll a 401(k) into an IRA — pros and cons

Pros:

  • Broader investment options and easier consolidation across multiple old employers.
  • Access to Roth conversions and specific tax strategies (Roth conversion ladder, partial conversions).
  • Typically more control over withdrawals and estate planning (e.g., stretch options in older rules; check current RMD and beneficiary rules).

Cons:

  • IRAs generally have weaker bankruptcy/creditor protection compared with some employer plans (ERISA protections can protect 401(k) balances from creditors).
  • Rolling into an IRA may eliminate access to certain plan-specific features like in-plan loans or company stock tax treatment.

Contribution strategy — how to use both accounts together

  1. Always contribute enough to your 401(k) to capture the employer match first.
  2. If you still have savings capacity, consider contributing to an IRA (traditional or Roth) for lower-cost investment choices or Roth tax diversification.
  3. Use tax diversification: balancing pre-tax (traditional) and after-tax (Roth) accounts reduces uncertainty about future tax rates.
  4. Consider catch-up contributions if you’re age 50 or older — both account types allow extra contributions subject to IRS rules.

In my practice, I often recommend a two-step approach: capture the employer match, then fund an IRA (often a Roth for younger or lower-income clients), and finally raise 401(k) contributions once IRA space is exhausted. That sequence balances immediate tax savings, long-term tax-free growth, and lower investment fees.

Common mistakes and how to avoid them

  • Treating an indirect rollover the same as a direct rollover: indirect rollovers often trigger mandatory 20% withholding and can create tax headaches if the 60-day rule isn’t met.
  • Assuming a Roth conversion is free: conversions trigger income tax; model the tax impact before converting large balances.
  • Overlooking plan documents and fees: always review the summary plan description and fee disclosures before rolling.
  • Forgetting beneficiary updates after a rollover: estate outcomes depend on current beneficiaries, not your prior wishes.

When to keep money in your old 401(k)

Sometimes the best move is to leave the money where it is. Reasons include:

  • Strong institutional investment options or lower fees negotiated by the employer.
  • ERISA creditor protection you’d lose by rolling into an IRA.
  • Plan-specific benefits such as in-plan Roth conversions, company stock treatment, or pension-linked rules.

Additional resources and internal guides

For official, up-to-date IRS guidance on contribution limits, rollovers, and tax effects see:

Final checklist and decision guide

  • Capture any employer match immediately.
  • Use direct rollovers to avoid withholding and the 60-day trap.
  • When converting to a Roth, plan for the tax bill and consider spreading conversions over years.
  • Compare fees, creditor protection, and investment options before consolidating accounts.
  • Update beneficiaries and confirm RMD rules that may apply.

Professional disclaimer: This article is educational and does not replace personalized tax, legal, or financial advice. Rules for contributions, rollovers, and required minimum distributions change periodically. Consult a CPA or CFP® for recommendations tailored to your situation and confirm current IRS limits and regulations at the links above.

Author credentials: I am a CFP® and CPA with 15+ years advising individuals on retirement planning and rollovers; I’ve helped clients avoid rollover taxes, capture employer matches, and design Roth conversion schedules to smooth tax liabilities.