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401(k) vs Savings Accounts: a Comparison

401(k) vs Savings Accounts: a Comparison
Austin Kilham
Austin KilhamUpdated May 17, 2023
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Editor’s note: Lantern by SoFi seeks to provide content that is objective, independent and accurate. Writers are separate from our business operation and do not receive direct compensation from advertisers or partners. Read more about our Editorial Guidelines and How We Make Money.
Saving for your future involves setting goals for the short- and long-term. You might be aiming to save for a down payment on a new car in the next year, while also saving for retirement decades down the road. Fortunately, there are different types of accounts to help you do these things, including savings accounts and tax-advantaged retirement accounts like 401(k)s. Each is built for a specific purpose and has its own set of rules. So, which is better, a 401(k) or a savings account? Here’s a look at a 401(k)vs. savings account, so you’ll know how and when to use them. 

What Is a 401(k)?

You might be wondering, is a 401(k) considered a savings account? Although it can help you save, a 401(k) is actually a tax-advantaged retirement plan offered through an employer. The money invested in a 401(k) is meant to grow over the years. Eventually, it can help you cover the costs of retirement.

How Does a 401(k) Work?

With a 401(k), employees contribute pre-tax income — up to $22,500 in 2023 — to the plan. These contributions reduce your taxable income for the year. After you retire and take distributions from a 401(k), you’ll pay taxes on the amount you withdraw, but you’re more likely to be in a lower tax bracket at that point, which could help you save money.The way a 401(k) works is that you sign up for the plan through your employer. You choose a percentage of each paycheck to be contributed to your 401(k), and that amount is usually automatically deposited into the plan.Employers can also contribute to 401(k) plans. Their contributions are typically matching funds, meaning that they match a certain percentage of the employee’s contribution. Combined employer and employee contributions to a 401(k) cannot exceed $66,000 in 2023, or $73,500 for those over age 50. A 401(k) plan generally has a list of funds that your contributions can be invested in. You pick which funds you’d like your money to go into.Investing in a 401(k) gives you the power of compounding returns because the returns on your investments are then reinvested, which generates additional earnings over time.  This can help you reach your savings goals.For the most part, once your money is invested in a 401(k), you can’t touch it until you turn 59½, at which point you can make withdrawals penalty free. There are certain exceptions to this rule.  You can borrow from your 401(k), penalty-free, if the plan allows it. But you’ll typically have to pay taxes on the money in the year that you take it out. You also must repay what you borrow within a certain timeframe with interest. If you don’t, the unpaid amount will be treated as a taxable distribution, and you may be subject to a 10% penalty. Recommended: How Many Bank Accounts Can and Should You Have?

What is a Roth 401(k)?

A Roth 401(k) is very similar to a traditional 401(k). The major difference is that with a Roth, contributions are made with after-tax dollars. That means the funds in the account can grow tax-free, and the withdrawals you make in retirement are not taxed. Roth 401(k)s may be beneficial for those who expect to be in a higher tax bracket when they retire. Also, it may be possible to have both a traditional 401(k) and a Roth 401(k) and split your contributions between them. Cumulative contributions cannot exceed the $22,500 limit for 2023. 

Pros and Cons of a 401(k)

There are distinct advantages, and also some disadvantages, to contributing to a 401(k).
• Contributions reduce your taxable income in the year they’re made, providing an immediate tax benefit.• Withdrawals from 401(k)s are taxed at normal income tax rates.
• Funds within the account grow tax-deferred, which helps you take greater advantage of compounding interest and ultimately can increase your total return.• It’s difficult to access 401(k) funds before you turn 59 1/2. Withdrawals before then will be taxed and may be subject to a 10% early withdrawal penalty.
• Employers may offer matching funds to increase total annual contributions.• Money borrowed from your 401(k) must be repaid with interest. 

401(k) vs Savings Account

You open a savings account at a bank, credit union, or online bank. It’s a secure place to stash some money for savings, and also earn a little interest at the same time. One of the main differences between a 401(k) vs. a savings account is that you don’t invest money through a savings account. To invest, you need to put money in a brokerage account, or a tax-advantaged account like a 401(k). Savings accounts are a safe place to keep money until you need to spend it on something. In fact, savings accounts are generally one of the most secure places you can put your money. The FDIC insures up to $250,000 of your savings per bank and per ownership category. That means customers with multiple accounts at one bank may qualify for more than $250,000 in coverage. When comparing savings accounts, be sure any bank you're considering is FDIC-insured.Here’s a side-by-side look at 401(k) vs. savings account: 
401(k)Savings account
• Company-sponsored tax-deferred retirement accounts• Interest-bearing deposit accounts.
• Only available through an employer• Anyone can open a savings account at a bank, credit union, or online bank.
• Come with contribution limits of $22,500 for 2023 (or $30,000 of those age 50 and older)• There is no contribution limit to savings accounts. However, there may be a minimum balance you need to maintain or you’ll be charged a fee.
• Contributions may be invested in certain funds.• Money held in a savings account cannot be invested
• Invested funds may earn a return.• Deposited funds earn interest.
• Funds may be withdrawn at age 59½ with no penalty, though the withdrawn amount will then be subject to income tax. Account holders must make required minimum distributions (RMDs) beginning at age 72.• Withdrawn funds are not taxed or penalized. Interest earnings may be subject to tax, however. Some financial institutions may place limits on how many withdrawals can be taken per month.
Recommended: Guide to Long-Term Savings Accounts and Tips for Choosing One

Pros and Cons of a Savings Account

The main benefit of starting a savings account is to have a safe place to save money you might need in the short-term. If you want to save for a trip, for instance, or you need to buy new appliances for your kitchen, you can place money in a savings account and withdraw it when you need it for those purchases.You can also use money in a savings account to cover sudden bills. For instance, many people keep an emergency fund in their savings account to pay for unexpected expenses, like medical bills or car repairs, or to tide them over if they lose their job. You might even choose to open multiple savings accounts for specific savings goals, such as one for an emergency fund and another for a vacation fund. That way, it won’t be tempting to spend money from one account on something it’s not earmarked for. You can automate your deposits to these accounts to make it even easier to work toward your savings goals. If you’re wondering about the difference between savings or checking accounts, savings accounts allow you to earn some interest, while checking accounts typically don’t. Although the interest earned with many savings accounts is fairly low, there are high-yield online bank accounts you can look into. These accounts may offer an interest rate that’s 20 to 25 times higher than the rate with traditional savings accounts. The main disadvantage of savings accounts is that the interest rate they earn tends to be lower compared to the potential returns available through investing. For this reason, you may want to put some money in savings, such as three to six months’ worth of expenses in an emergency fund, and allocate other money to accounts where it can earn a higher return, like a tax-advantaged 401(k) account or a taxable brokerage account. In addition, some financial institutions may place limits on how often you can withdraw money from a savings account each month. You might also be required to keep a minimum balance in the account or you’ll be charged a fee. Recommended: What Do You Need to Open a Bank Account?

Using a 401(k) and Savings Account

So, should you open a 401(k) or savings account? It’s often wise to open both. A 401(k) will help you save for retirement through investing and the power of compounding returns.  And you’ll enjoy some tax breaks along the way. But money in a 401(k) isn’t accessible, for the most part, until you’re almost 60. If you withdraw funds from a 401(k) before age 59½, you may have to pay a 10% early withdrawal penalty in addition to taxes. Money in a savings account, on the other hand, is available whenever you need it. That’s why savings accounts are beneficial for funds you might need in an emergency or in the short-term. And if it’s a high-yield account, you can earn a competitive interest while you’re saving.Also, consider this: When you start to make withdrawals from your 401(k), you’ll need to stash that money somewhere. A savings account might be the perfect place.

The Takeaway

Savings accounts and 401(k)s are important tools for saving and earning money in the short and long term. Knowing how to use each of them will help you maximize their specific benefits as you work toward your financial goals. If you’re ready to open a savings account that gives you a higher rate of return, Lantern by SoFi can help. In our online banking marketplace, you can easily and conveniently compare high-yield savings accounts by APY (annual percentage yield), fees, and balance minimums to help find the best option for you. Find today’s top rate with Lantern.

Frequently Asked Questions

Is it better to have a savings account or a 401(k)?
Is a savings account good for retirement?
Can I use my 401(k) as a savings account?
Photo credit: iStock/Prostock-Studio

About the Author

Austin Kilham

Austin Kilham

Austin Kilham is a writer and journalist based in Los Angeles. He focuses on personal finance, retirement, business, and health care with an eye toward helping others understand complex topics.
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