RS105

Individual Retirement Accounts (IRAs) Explained

How IRAs Work Alongside a Workplace Plan, and When You Might Need One

What You'll Learn

By the end of this lesson, you’ll understand:

  • What an IRA is and how it’s different from a 401(k)
  • The difference between a Traditional IRA and a Roth IRA
  • Who can contribute, and the income limits that can apply
  • How an IRA can work alongside a workplace plan
  • What a rollover IRA is
  • How IRA contribution limits compare to workplace plan limits

Why This Matters

Not everyone has access to a workplace retirement plan, and even people who do often have good reasons to also use an IRA.

Understanding how an IRA works, and how it’s different from a 401(k), helps you use both accounts intentionally instead of treating them as interchangeable.

What Is an IRA?

An Individual Retirement Account (IRA) is a retirement account you open yourself, generally through a brokerage or bank, rather than through an employer.

Unlike a 401(k), an IRA isn’t tied to your job. You can open one whether or not your employer offers a retirement plan, and it stays with you regardless of where you work.

Like a 401(k), an IRA is an account type, not an investment itself, you still choose investments to hold inside it from what your IRA provider makes available, which is often a much wider selection than a typical 401(k) menu.

How an IRA Differs From a 401(k)

  • A 401(k) is offered through an employer; an IRA is opened individually
  • A 401(k) may include an employer match; an IRA does not, since there’s no employer involved
  • A 401(k)’s investment menu is set by the plan; an IRA generally offers a much broader range of investment choices
  • Contribution limits differ significantly between the two, generally allowing much larger 401(k) contributions

These differences don’t make one account “better” than the other in every case, they serve different purposes and are often used together.

Traditional IRA vs. Roth IRA

Like a 401(k), an IRA can be structured as Traditional or Roth, following the same core tax distinction covered in the previous lesson.

Traditional IRARoth IRA
ContributionsMay be tax-deductible, depending on income and workplace plan coverageMade with after-tax dollars, not deductible
Withdrawals in retirementGenerally taxed as ordinary incomeGenerally tax-free if qualified
Income limitsDeductibility can phase out at higher incomes if you’re also covered by a workplace planContribution eligibility can phase out entirely at higher incomes

The Traditional IRA’s deductibility rules are more layered than a 401(k)’s pre-tax treatment: if you’re also covered by a workplace retirement plan, your ability to deduct a Traditional IRA contribution can be reduced or eliminated at higher income levels. This is worth checking against current IRS rules for your specific situation.

Who Can Contribute to an IRA

Generally, you need taxable compensation, income from work, to contribute to an IRA. Beyond that basic requirement, eligibility depends on the type of IRA and your income:

  • Traditional IRA contributions are generally available regardless of income, though the tax deduction may be limited if you’re also covered by a workplace plan
  • Roth IRA contributions are limited, and eventually phased out entirely, above certain income thresholds that the IRS updates periodically

Because these income thresholds change over time, they should be confirmed against current IRS guidance rather than assumed to be fixed.

How an IRA Can Work Alongside a Workplace Plan

Many people use both a 401(k) and an IRA, for a few common reasons:

  • Contributing enough to a 401(k) to capture the full employer match, then directing additional savings to an IRA for its wider investment selection
  • Using an IRA to hold savings from a previous employer’s plan, through a rollover
  • Using an IRA to access a Roth option, if their 401(k) doesn’t offer one
  • Using an IRA for additional retirement savings beyond what fits comfortably into their 401(k) contribution strategy

There’s no requirement to choose only one account type. Many complete retirement strategies use both together, each serving a different role.

What a Rollover IRA Is

A rollover IRA is an IRA specifically used to receive funds from a previous employer’s retirement plan, such as a 401(k) from a job you’ve left.

Rolling funds from an old 401(k) into an IRA can consolidate old accounts, potentially expand your investment options, and keep the money in a tax-advantaged account rather than triggering an early distribution.

This process, done correctly, is generally not a taxable event. Done incorrectly, for example, receiving a distribution check and not redepositing it within the required time frame, it can trigger taxes and penalties. A later lesson in this course covers 401(k) rollovers in more detail.

Contribution Limits: IRA vs. Workplace Plan

IRA contribution limits are generally significantly lower than 401(k) contribution limits, and both are set annually by the IRS and can change from year to year.

As a simplified illustration of the relationship: a typical annual IRA limit has historically been roughly one-fifth to one-third of a typical 401(k) employee contribution limit, though the exact current figures should always be confirmed directly with the IRS or your account provider rather than assumed from a prior year.

This is one reason many people prioritize their 401(k) match first, then consider an IRA, then return to their 401(k) for contributions beyond the IRA limit if they’re able to save more.

A Realistic Example

Sam’s employer offers a 401(k) with a match, but a fairly limited investment menu of eight funds. Sam contributes enough to capture the full match, then opens a Roth IRA to continue saving beyond that.

The Roth IRA gives Sam access to a much broader set of investment choices than the 401(k) menu allows, and Sam’s income is low enough this year to qualify for full Roth IRA contributions.

A few years later, Sam changes jobs. Rather than leaving the old 401(k) behind or cashing it out, Sam rolls it into a separate rollover IRA, keeping the funds invested and tax-advantaged while consolidating old accounts.

Sam now manages three pieces: an active 401(k) at the current employer, a Roth IRA for additional personal savings, and a rollover IRA holding funds from the previous job, each serving a distinct purpose.

Common Mistakes With IRAs

Assuming an IRA Replaces a 401(k) Match

If an employer offers a match, capturing it first is generally worth prioritizing before directing money to an IRA instead.

Missing the Roth IRA Income Limit

Contributing to a Roth IRA above the income limit can create a correction process that’s worth avoiding by checking current limits first.

Leaving an Old 401(k) Behind Without a Plan

An old 401(k) left with a former employer is still your money, but it’s easy to lose track of, and may carry fees or a limited investment menu.

Cashing Out an Old 401(k) Instead of Rolling It Over

Cashing out early can trigger taxes and penalties, in addition to permanently losing the account’s future growth.

Common Myths About IRAs

Myth

I can’t have an IRA if I already have a 401(k) at work.

Fact

Most people can contribute to both, though the tax deductibility of a Traditional IRA contribution can be affected by workplace plan coverage and income.

Myth

An IRA is only for people without access to a 401(k).

Fact

Many people with a 401(k) also use an IRA for additional savings, a Roth option, or to hold rolled-over funds from a previous job.

Myth

Rolling over a 401(k) always creates a tax bill.

Fact

A properly executed rollover between tax-advantaged accounts is generally not a taxable event. Errors in how the rollover is handled are what typically create tax consequences.

Myth

IRA contribution limits are the same as 401(k) limits.

Fact

IRA limits are generally significantly lower than 401(k) employee contribution limits, and both change periodically.

  • Confirm current IRA contribution limits and income eligibility each year before contributing
  • Prioritize capturing a workplace match before directing savings to an IRA instead
  • Keep track of old 401(k)s from previous employers rather than leaving them unmanaged
  • Consolidate old accounts into a rollover IRA deliberately, not by default

Frequently Asked Questions

Generally yes, but your combined contributions across both are still subject to the same total annual IRA limit, not a separate limit for each.

Excess contributions can be subject to a penalty if not corrected within a specific time frame. Most account providers can help you correct an excess contribution if you catch it early.

A rollover IRA is simply an IRA used to receive funds from a previous employer plan, it follows the same IRA rules, though some people keep rollover funds separate from new personal contributions for record-keeping purposes.

No, but leaving it unmanaged for years makes it easier to lose track of, and it may not benefit from the same fee structure or investment choices you could get by consolidating it.

Rules vary by IRA type and depend on whether you’re withdrawing contributions or earnings, and your age. Early withdrawals can trigger taxes and penalties in many circumstances, this is worth reviewing carefully before acting, ideally with a tax professional.

Your One Actionable Takeaway

Check whether you currently have any old 401(k) accounts from previous employers, and if so, look up whether they qualify for a rollover into an IRA.

If you don’t have an IRA yet, this is also a good time to research whether one could complement your current workplace plan.

Your Next Best Step

You now understand the two most common types of retirement accounts. The next lesson brings them together with a practical question: how much should you actually be contributing?

In the next lesson, you will learn:

  • How to translate a percentage-based goal into a specific dollar contribution
  • What contribution rate is required to capture your full employer match
  • How IRS contribution limits work and how they change over time
  • The difference between your contribution limit and a realistic personal target
  • How to increase your contribution rate gradually without disrupting your budget
  • How to balance retirement contributions against other financial priorities

Understanding your accounts is the foundation. The next lesson turns that understanding into an actual number for your own budget.

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