Retirement Account Contributions: 401(k) vs IRA Tax Benefits

Why Retirement Accounts Are the Best Tax Tool

Retirement accounts offer the most powerful tax benefits available to ordinary taxpayers. Every dollar you contribute to a traditional 401(k) or IRA reduces your taxable income immediately, and the investments grow tax-deferred until you withdraw them in retirement. Roth versions flip this: you pay tax now but never pay tax on growth or withdrawals.

Understanding the differences between these accounts and knowing how to use them strategically can save you hundreds of thousands of dollars in taxes over your lifetime.

401(k) Plans: Employer-Sponsored Retirement

2025 Contribution Limits

Employee contribution: $23,500

Catch-up contribution (age 50-59, 64+): Additional $7,500 (total: $31,000)

Super catch-up (age 60-63): Additional $11,250 (total: $34,750)

Total limit including employer contributions: $70,000

Traditional 401(k) Tax Benefits

Contributions are pre-tax, meaning they reduce your taxable income in the year you contribute. If you are in the 24% tax bracket and contribute $23,500, you save $5,640 in federal income tax immediately. Your investments grow tax-deferred, and you pay income tax on withdrawals in retirement.

Roth 401(k) Tax Benefits

Contributions are after-tax (no immediate tax break), but all qualified withdrawals in retirement, including decades of investment growth, are completely tax-free. A Roth 401(k) is advantageous if you expect to be in a higher tax bracket in retirement.

Employer Match

Many employers match a percentage of your contributions, typically 50-100% of the first 3-6% of salary. This is free money. Always contribute at least enough to capture the full employer match before considering other accounts.

Example: Your employer matches 100% of the first 4% of your $100,000 salary. Contributing 4% ($4,000) earns you a free $4,000 match. Not contributing means leaving $4,000 on the table every year.

Employer matching contributions are always pre-tax, even if you make Roth 401(k) contributions. They go into a separate traditional account.

IRA: Individual Retirement Account

2025 Contribution Limits

Standard contribution: $7,000

Catch-up contribution (age 50+): Additional $1,000 (total: $8,000)

Traditional IRA Tax Benefits

Contributions may be tax-deductible depending on your income and whether you have access to an employer retirement plan:

No employer plan: Fully deductible at any income level.

With employer plan (single):

AGI up to $79,000: Fully deductible

AGI $79,000-$89,000: Partially deductible

AGI above $89,000: Not deductible

With employer plan (married filing jointly):

AGI up to $126,000: Fully deductible

AGI $126,000-$146,000: Partially deductible

AGI above $146,000: Not deductible

Even if contributions are not deductible, the investments still grow tax-deferred. However, a non-deductible traditional IRA is less attractive than a Roth IRA in most cases.

Roth IRA Tax Benefits

No tax deduction on contributions, but withdrawals in retirement (after age 59.5 and the account has been open 5+ years) are completely tax-free. Additionally, Roth IRAs have no required minimum distributions during the owner's lifetime.

Income limits for direct Roth IRA contributions:

Single: Phases out between $150,000-$165,000 AGI

Married filing jointly: Phases out between $236,000-$246,000 AGI

Backdoor Roth IRA

If your income exceeds Roth IRA limits, use the backdoor strategy:

Contribute to a non-deductible traditional IRA ($7,000)

Convert to Roth IRA (pay tax on any gains, which should be minimal if done quickly)

This is legal and widely used, but be aware of the pro-rata rule: if you have existing pre-tax IRA balances, the conversion is partially taxable based on the ratio of pre-tax to after-tax funds across all your traditional IRAs.

Self-Employed Retirement Options

SEP IRA

Contribute up to 25% of net self-employment income (maximum $70,000). Simple to set up, no annual reporting, and contributions can be made until your tax filing deadline including extensions. Ideal for self-employed individuals with variable income.

Solo 401(k)

Contribute as both employee ($23,500) and employer (25% of net income) up to $70,000 total. Offers a Roth option. Best for high-earning solo business owners who want to maximize contributions. Use our freelance tax calculator to compare options.

SIMPLE IRA

Employee contributions up to $16,500 with mandatory employer matching (dollar for dollar up to 3% of compensation). Designed for small businesses with employees.

Traditional vs Roth: The Decision Framework

Choose Traditional When

You are currently in a high tax bracket (32% or above)

You expect to be in a lower bracket in retirement

You need the immediate tax deduction for cash flow

You plan to retire in a state with no income tax

Choose Roth When

You are currently in a lower tax bracket (12-22%)

You expect to be in a higher bracket later (early career, rising income)

You want tax-free income flexibility in retirement

You want to avoid required minimum distributions

You believe tax rates will rise in the future

The Hybrid Approach

Many financial planners recommend contributing to both traditional and Roth accounts to create tax diversification. In retirement, you can withdraw from traditional accounts up to the top of a low bracket, then use Roth funds for additional spending without pushing yourself into higher brackets.

Optimal Contribution Order

If you have limited funds, prioritize in this order:

401(k) up to employer match: Free money, always first

HSA (if eligible): Triple tax advantage, use our retirement tax calculator to model the impact

Roth IRA: Tax-free growth and no RMDs

401(k) up to maximum: Additional tax-deferred or Roth growth

Taxable brokerage account: After maximizing all tax-advantaged space

The Power of Tax-Deferred Growth

Consider two investors who each earn $100,000 and invest $23,500 per year for 30 years at 8% average annual return:

Investor A (401(k)): Invests $23,500 pre-tax, grows to $2,871,000. Pays income tax on withdrawals but had the full $23,500 working for them each year.

Investor B (taxable account): Pays 24% tax first, invests $17,860 after tax, grows to $2,183,000. Also pays capital gains tax on growth annually, reducing the effective return.

The difference of nearly $700,000 illustrates why tax-advantaged accounts should be maximized before investing in taxable accounts.

Key Deadlines

401(k) contributions: December 31 of the tax year (through payroll)

IRA contributions: April 15 of the following year (April 15, 2026, for 2025)

SEP IRA contributions: Tax filing deadline including extensions (October 15, 2026, for 2025 if extended)

Common Mistakes to Avoid

Not contributing enough to get the full match: This is the highest guaranteed return in investing.

Choosing traditional when Roth makes sense: Early-career workers in low brackets benefit enormously from Roth contributions that will grow tax-free for decades.

Ignoring the backdoor Roth: High earners who assume they cannot contribute to a Roth miss out on a legitimate planning strategy.

Forgetting to invest after contributing: Money sitting in a retirement account default money market fund does not grow. Choose investments that match your time horizon and risk tolerance.

Taxation.ai models the long-term tax impact of different retirement contribution strategies and recommends the optimal allocation between traditional, Roth, and other accounts based on your specific income, age, and retirement goals.