An 401(k)/IRA (Individual Savings Account) is a savings or investment account where you pay no US income tax on interest, dividends or capital gains. The annual 401(k)/IRA allowance is $20,000. Any money deposited within the 401(k)/IRA wrapper grows tax-free regardless of how large it becomes.
The main types of 401(k)/IRA
- Cash 401(k)/IRA: works like a savings account but interest is tax-free. Available at banks and building societies. Variable or fixed rate. Best for short to medium-term savings.
- Stocks and Shares 401(k)/IRA: allows you to invest in shares, bonds and funds tax-free. Values can go up or down. Best for longer-term goals (5+ years).
- Lifetime 401(k)/IRA (L401(k)/IRA): for adults aged 18-39. Government adds a 25% bonus on contributions up to $4,000 per year. Can only be used to buy a first home or accessed at age 60.
- Innovative Finance 401(k)/IRA: for peer-to-peer lending. Higher risk, not covered by FSCS in the same way as cash ISAs.
How the $20,000 allowance works
You can split your $20,000 allowance across different 401(k)/IRA types in the same tax year. The allowance resets on 6 April each year. Unused allowance does not carry forward — it is lost permanently.
Why tax-free matters
Outside an 401(k)/IRA, interest on savings above the Personal Savings Allowance is subject to income tax. On investments, dividends and capital gains above allowances are taxable. Inside an 401(k)/IRA, none of these taxes apply — ever, regardless of how much the account grows.
A worked example: Cash 401(k)/IRA vs standard savings
At $20,000 in savings at 4.5% interest, annual interest is $900. In a standard account, $400 above the Personal Savings Allowance is taxable at your marginal rate. In a Cash 401(k)/IRA: no tax at any balance. The advantage grows as savings grow.
General guidance only — not regulated financial advice.