Is it better to use this option in my 401k plan, or just set up an IRA outside of my employer's plan?
Geraldine - I suggest that you fully fund your 401k first, as you will see a tax benefit from a lower reported income and also receive whatever your employer matches on contributions. If you have the income to spare, you may want to make a non-deductible IRA contribution. You won't enjoy the tax deduction, but you will shelter the income and growth on that investment from taxes within the IRA until the time they are withdrawn.
Non-deductible retirement plan contributions, such as non-deductible IRA, ROTH, and ROTH 401k contributions, differ from traditional pre-tax plans in that account contributions are made with after-tax rather than pre-tax income. The downside is that your current period taxable income is higher by making non-deductible contributions than it would be if you make a pre-tax or tax-deductible plan contribution. However, the reward is that because tax has already been paid, these after-tax amounts can grow on a tax-free basis in most cases.
Depending on your particular circumstances, it could make sense to take advantage of your employer's plan AND set up an account outside of the plan. With regard to the latter, if you do not currently have any pre-tax IRAs and your income is too high to make a direct ROTH contribution, you should make a non-deductible IRA contribution and convert the account immediately to a ROTH to maximize your benefit. If you do have one or more pre-tax IRAs, the issue is more complex and requires analysis by you or your advisor. This is also true if you cannot contribute the maximum annual amount to your retirement plans, or if you expect your marginal tax rate to decline after you retire.
You may be interested in the financial guide (linked below) which highlights some of the key differences between traditional and ROTH accounts. It can help point you in the right direction for further analysis and review. Good luck to you, and feel free to respond back with other questions or comments.