Choosing between investing in a 401(k), IRA or taxable account comes down to your financial goals, ... [+]
Determining whether you should max out your 401(k) before investing in an IRA or stocks is a complicated decision based on a number of factors, including your 401(k) quality, financial goals, risk tolerance and investing knowledge. In this article, you’ll learn the essential differences between 401(k)s, IRAs and stock investing through a taxable account, when it’s essential to invest in your 401(k) first, and examples of when diversification across account types is the smarter move.
An Overview Of 401(k), IRA And Stock Investing
401(k)s, IRAs and stock investing through a taxable account are all unique investing vehicles which carry pros and cons you should be aware of before making your allocation decision.
401(k)s are employer-sponsored retirement accounts which allow employees to contribute pre- or post-tax income from their paycheck. 401(k)s are tax-advantaged with options to make pre-tax contributions via a traditional 401(k) through which taxes are deferred until funds are withdrawn at retirement. Roth 401(k) contributions are made with post-tax dollars and can grow tax-free with no taxes when funds are withdrawn at retirement. 401(k)s can also come with employer matches.
IRAs, or individual retirement accounts, are retirement accounts which offer tax advantages like 401(k)s depending on whether you choose a traditional IRA, which is tax-deferred, or a Roth IRA, which offers tax-free withdrawals. IRAs can be opened with brokerage firms like Charles Schwab or Fidelity and don’t require employer sponsorship. IRAs have lower annual contribution limits compared with 401(k)s but offer greater flexibility in terms of investment selection, including individual stocks.
Finally, stock investing is a type of investment by which you purchase shares of companies to grow your investment through growth or dividend income. Stock investing is usually riskier than investing in shares of ETFs, mutual funds or index funds because of less diversification across companies or sectors. Stock investing through a taxable account also doesn’t offer the tax advantages that you could get by investing through a 401(k) or IRA.
Understanding When To Prioritize Investing In A 401(k)
A primary reason to prioritize investing in your 401(k) is if your employer offers a match. An employer match is basically free money you can earn by making the required contribution according to your plan. As an example, if your employer matches 50% of your contributions up to 6% of your salary and you earn $60,000, you can earn $1,800 just by contributing $3,600.
Once you’ve earned your employer match, it may be worthwhile to continue investing through your 401(k) like if you want the simplicity of saving for retirement through automated contributions or through a single account, if you’re happy with investment options in your 401(k), and if fund or provider fees are reasonable.
Should You Max Out Your 401(k) First Before Investing In An IRA?
There are a number of factors you should consider when evaluating whether you should max out your 401(k) before investing in an IRA. For example, if you wish to earn your full employer match, want to access investment options available only through an IRA or taxable account, or want to set-and-forget your retirement contributions.
When Maxing Out Makes Sense
Maxing your 401(k) out first before investing in an IRA may make sense if your employer offers a match, your plan has low fees and you’re satisfied with fund options. High income earners who no longer qualify to contribute to a Roth IRA should consider contributing to their Roth 401(k), which doesn’t carry income maximums. Read more about Roth IRA contribution limits in 2025.
High-income earners can benefit from maxing out their 401(k), which has a higher annual limit than an IRA and thus can offer more tax-deferred or tax-free growth. Another benefit of maxing out your 401(k) is you can set and forget your contribution from your paychecks with your provider, reducing the friction of having to manually move money into your taxable or IRA accounts.
When To Consider Diversifying And Investing Elsewhere
It may be worthwhile to consider diversifying into an IRA and stocks if your 401(k) plan has high fees or you’re unsatisfied with fund options. With an IRA or taxable account, you can select your brokerage firm based on experience, fees and investment options. An IRA also allows you to invest in either funds or individual stocks if you wish to access tax advantages while being more deliberate in your investment approach.
Diversifying your approach can also make sense if you wish to just earn your employer match while still maintaining greater access to investment options through your IRA or brokerage account. If you wish to save for medium-term goals like saving for a house or retirement, you could also earn your employer match and then invest other funds into individual stocks in a taxable account through which funds aren’t locked up until retirement.
Factors To Consider Before Deciding Where To Invest
There are a number of factors to consider when deciding which accounts to invest in. By weighing your financial goals, timeline, financial circumstances and risk tolerance, you can determine whether you should first max out your 401(k) before investing in an IRA or stocks.
Your Financial Goals
Financial goals are a major determinant of whether you should prioritize investing in a 401(k) before an IRA or stocks. If you’re investing primarily for retirement, you should focus on maximizing your 401(k), especially to maximize an employer match, as well as your IRA. If you’re focused on more medium term goals which are five years or longer out, like paying for an education or a house, you should consider investing in stocks or other assets in a taxable account. These are some of the best stocks for 2025 to consider.
Most people are saving for multiple goals like retirement, a house or a future vacation, so determining your priorities, the time horizon of your goals, and return of your investments will help you make the right investment choices.
Current Financial Situation
Assessing your financial situation including your income, expenses, current holdings and pressing priorities like paying off student debt or a mortgage will help you make the right decision of where to invest. For example, if you need to pay off higher-interest student debt, it may be more important to aggressively pay off this debt while just contributing enough to your 401(k) to get an employer match.
Your tax situation could also factor into your account and investment decisions. For example, if you’re a high-income earner in a high-tax state, you could benefit from investing in tax-deferred accounts like a traditional 401(k) or IRA to reduce your taxable income. If you're in a low tax bracket or lower-income tax state, it may benefit you to invest through Roth accounts to access tax-free withdrawals when you retire.
Risk Tolerance
Your risk tolerance can also affect your account and investment allocation based on your personal risk preference and time horizon. Generally, a 401(k) and IRA carry less risk than taxable accounts as they offer tax advantages and broader diversification through fund access than investing in individual stocks through a taxable account. One exception to this is if you’re investing through retirement accounts in funds like bond funds, which won’t deliver a sufficient return to support your spending in retirement.
Time horizon is an important aspect of risk tolerance. If you’re a younger investor, you can afford more risk in your portfolio by investing in individual stocks in taxable accounts but you can also access higher-risk and return investments by investing in stock funds in a 401(k) or IRA. Older investors should also invest in retirement accounts to gain tax advantages for their portfolio while they still earn an income.
Bottom Line
Ultimately, choosing between investing in a 401(k), IRA, taxable account or a combination of two or three of these comes down to your financial goals, risk tolerance and your financial situation. 401(k)s are an amazing investment vehicle with high contribution limits which are great if you wish to maximize your employer match and are content with your 401(k) provider and options. The limit for 401(k) contributions in 2025 is $23,500.
An IRA can be more ideal if you want more investment options while still reaping retirement tax advantages. And finally, stock investing is ideal if you wish to save for financial goals outside of retirement or you want more liquid access to funds.
Diversifying contributions across these account types is a viable option if you have a higher income or wish to reap the benefits of each account type.
