Why IRAs Hold More Money Than 401(k)s

IRAs are now the primary way workers are saving for retirement.

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Workers can contribute up to $17,500 to a 401(k) in 2013, which jumps to $23,000 if you are age 50 or older. That’s over three times more than the $5,500 (or $6,500 at age 50 or older) that workers can contribute to IRAs. And yet workers have much more money invested in IRAs. Investors collectively held $4.87 trillion in IRA accounts in 2011, compared to $3.88 trillion in private-sector defined contribution plans like 401(k)s, according to Federal Reserve data. Here’s a look at why IRAs collectively hold more cash than 401(k) plans:

[Read: How to Take 401(k) Withdrawals.]

Not everyone has a 401(k) at work. Only about half (49 percent) of employed Americans work for a company that sponsors a retirement plan, and just 40 percent participated in the retirement account in 2011, according to an Employee Benefit Research Institute analysis of Census Bureau data. IRA accounts are not attached to your job, so workers with earned income can participate even if their current employer doesn’t offer a retirement plan. In fact, the ability to make tax-deductible IRA contributions is phased out if you have a retirement plan at work and a modified adjusted gross income between $59,000 and $69,000 in 2013 ($95,000 and $115,000 for couples). For investors without a workplace retirement plan who are married to someone with a 401(k), the deduction is phased out when the couple's income is between $178,000 and $188,000.

Rollovers. Few workers enjoy lifelong employment with a single company or have a single 401(k) plan that they can save in until retirement. When workers change jobs they can choose to leave the money in the old 401(k) plan, move it to their new employer’s plan, or roll their savings over to an IRA. Perhaps depending on how good the investment options are in the new 401(k) plan, many workers opt to move their money to an IRA each time they change jobs. “Many IRAs are funded with rollover dollars,” says Ken Hevert, vice president for small business retirement products at Fidelity Investments. “When individuals change jobs or they retire, at some point people end up moving their money out of that old plan and into an IRA.”

[Read: Smart Strategies for 401(k) Rollovers to IRAs.]

Lower fees. While a few 401(k) plans negotiate ultra-low fees on behalf of their employees, many do not. And if your 401(k) plan only offers high-cost funds, you are generally stuck with the investment options unless you can convince your employer to change the fund lineup. Investing in an IRA allows cost-conscious investors to seek out the lowest cost funds the marketplace has to offer.

More investment choices. 401(k) plans offer a limited number of investment options chosen by the plan administrator. If those investment options don’t meet your needs, you might instead choose to save outside the 401(k) plan. One common strategy is to save enough in a 401(k) plan to get any 401(k) match offered, and then direct additional savings to an alternative account like an IRA where you have more investment choices.

[Read: 401(k) and IRA Changes Coming in 2013.]

Saving in both. Many retirement savers have both a 401(k) and an IRA. A recent Fidelity Investments analysis of 999,000 investors using both a 401(k) and an IRA administered by Fidelity found that the average combined balance was $225,600 at the end of 2012, nearly three times higher than the average Fidelity 401(k) balance of $77,300. “If you have access to a workplace-sponsored retirement plan and they offer a match, that should be number one,” says Hevert. But then he advises establishing an emergency fund and paying down high-interest credit card debt before doing additional retirement saving. “Once you get those three steps, then it’s time to start saving some more.”