Having a 401(k) and an IRA is not only allowed, it’s actually quite common. However, depending on the structure of the accounts as well as your gross income, you could be limited in your IRA tax-deductible contributions. Although IRAs have a wider net for investment options, a 401(k) should always take priority if the employer will match the contribution.
Some of us can never have too many options to make us feel safe when it comes to retirement. For those looking to replicate their current quality of life in their golden years, a retirement plan might consist of multiple retirement accounts, a property portfolio, a stock portfolio, and even a bit of hard gold for good measure. In the case of retirement plans with tax incentives such as 401(k)s and IRAs, savers are allowed to have both but not necessarily claim full tax incentives for both.
Can I contribute to both a 401(k) and an IRA?
You can contribute to both a 401(k) and an IRA up to each account’s maximum annual contribution limit. However, there are income limits that can prevent maximum IRA deductions if the employee also has a 401(k). Furthermore, your spouse’s employment and retirement plan status can also affect your IRA contribution limits.
Why 401(k)s are important
Many companies, once they reach a certain size, will offer a 401(k) savings plan for their employees. What sets the 401(k) apart from other retirement vehicles, however, is a large employer’s ability to match the employee’s contribution to the 401(k). This, above all else, is why 401(k)s are crucial. From a tax perspective, 401(k)s reduce both your adjusted gross income (AGI) and modified adjusted gross income (MAGI). In short, regular 401(k) contributions can reduce your taxable income.
If you have the option of either an IRA or 401(k) and your employer is willing to match your 401(k) up to a certain amount, GO WITH THE 401(k). You should at least contribute as much as the employer is willing to match. The only major drawback with 401(k)s is the narrow window of investment options, according to Collen Clark, an attorney specializing in the subject. “When it comes to a 401(k), one of the potential downsides is limited investment options. Many 401(k) plans offer a predetermined selection of investments, which might not align perfectly with an individual’s financial goals or risk tolerance.”
401(k) contribution limit examples
$20,500 – under 50 years old
$27,000 – over 50 years old
$22,500 – under 50 years old
$29,000 – over 50 years old
Pros and cons of a 401(k)
The main benefit of a 401(k) is the employer’s ability to match the money you contribute, whereas the main drawback is the narrow options available for investing through a 401(k). Below are some factors to take into account when considering a 401(k).
Here is a list of the pros and cons of 401(k)s to consider.
- Employer matching programs
- Earlier penalty-free access
- High contribution limits
- High fees associated with the account
- Few investment opportunities for your funds
- Tax implications for withdrawals
Why IRAs are important
IRAs do not allow nearly as high contribution limits but offer much more in regard to selection of investments. However, it’s important to note that not all IRAs are eligible for employer matching; only a SIMPLE IRA is eligible. A SIMPLE IRA stands for “Savings Incentive Match Plan for Employees” and is usually only associated with smaller businesses. A SEP IRA is another employer-sponsored IRA, but only the employer can contribute. In fact, there are a few IRAs that have benefits, according to Gilbert Gallahar, a financial advisor with Prudential.
“To make an informed decision, it’s crucial to weigh the benefits of each IRA type — traditional, Roth, SEP, and SIMPLE,” he says. “Traditional IRAs offer upfront tax deductions but are taxed upon withdrawal. Roth IRAs, on the other hand, provide tax-free withdrawals in retirement, but contributions are made with after-tax dollars. SEP and SIMPLE IRAs are tailored for self-employed individuals and small business owners, offering higher contribution limits and potential tax benefits.”
With IRAs, the choice of investment options is far greater than a 401(k) for those looking to diversify as much as possible. However, the contribution limits are much smaller with an IRA, as you can see below. “For IRAs, the biggest issue is the ultra-low contribution limit, which is just $6,000 as of 2023,” says Jake Hill, a financial professional and CEO of DebtHammer. “This makes it difficult to grow your retirement savings as quickly as you may wish to do so. If you have beneficiaries for retirement accounts or any other parts of your estate, it’s important to name them in an official capacity as early as possible. This avoids potential disputes or misappropriation of funds in the event of your death.”
IRA contribution limits
Here are those IRA contribution limits:
$6,000 – under 50 years old
$7,000 – over 50 years old
$6,500 – under 50 years old
$7,500 – over 50 years old
See the IRS for the latest limits.
IRA pros and cons
Below are some of the pros and cons of using an IRA as a retirement savings account.
Here is a list of the benefits and the drawbacks to consider.
- Easy to set up traditional or Roth versions
- Available to anyone with earned income
- A wide swath of investment choices
- Relatively low contribution limits
- Deductibility of contributions is limited due to income
- No investment advice
Why it can be tricky to get a tax deduction for an IRA with an existing 401(k)
With a traditional IRA (not a Roth), the contributions are made to the IRA account with “tax deferred” status. This means that money contributed to the IRA is not taxed on the source, but the earnings will be taxed when the plan is realized. For instance, if you contribute $3,000 to an IRA, that $3,000 is deducted from your taxable income.
This is important because although the limits on IRAs are smaller, any tax incentive or deduction is a huge plus. If you have a 401(k) that is already with your employer, then you will need to refer to IRA income limits, and some, if not all, of those contributions could be taxable. It’s possible to deduct only a portion of your IRA contribution but only in special cases.
If you have questions about what is deductible, you can get help from these tax preparation services.
How much can I contribute to an IRA if I also have a 401k?
You can contribute however much you want to an IRA as long as you are within contribution limits. However, in terms of tax deductions, if you already have a 401(k), you could be over the limit.
Can you contribute to a traditional IRA and a 401k at the same time?
Yes, you can contribute to both at the same time as vehicles for your retirement savings. In fact, diversification is the name of the game when it comes to retirement planning, according to Dana Ronald, CEO of the Tax Crisis Institute and an IRS-enrolled agent. “When it comes to 401(k) and IRAs, the worst thing is usually a lack of diversification. If you don’t spread your money across multiple investments, you could take on more risk than necessary. The only item that an existing 401(k) will affect is the tax deductions on IRA contributions. Furthermore, if you are married, an existing spouse’s 401(k) can have a similar impact on tax deductions.”
Can I still contribute an IRA if I have 401k at work?
Yes, you can, and that includes Roth IRA contributions as well. A 401(k) is usually an employer-sponsored retirement plan, whereas an IRA is typically a private entity. The only exception is the SIMPLE IRA, but that is typically only associated with smaller businesses. IRAs in principle, work very similarly to a taxable brokerage account, but with tax advantages.
Can I contribute 100% of my salary to an IRA?
If your entire salary is within the IRA contribution limits, then of course you can. That goes for a traditional or Roth IRA.
What happens if I contribute more than $6,000 to my IRA?
If you contribute more than your contribution limit, you have three options: complete a return of excess funds form, re-file your distributions, or move them to the next year. If you are consistently above the IRA contribution limit, then you must pay a penalty on excess funds. At the time of this writing, that penalty is a 6% tax on the excess funds.
- Having a 401(k) in addition to an IRA is not only allowed, it’s actually quite common. However, depending on the structure of the accounts as well as your gross income, you could be limited in your IRA tax-deductible contributions.
- A 401(k) plan, in many cases, is matched by the employer up to a certain limit. You should take this extra money into account when deciding between an IRA and 401(k).
- An IRA is typically a private retirement plan sold by a broker or agent unless it’s a SIMPLE IRA. Your tax deductions on an IRA can indeed be affected by an existing 401(k) plan.
- Even if you don’t have a 401(k) plan, if your spouse does, this can also have an effect on your ability to deduct taxes via IRA contributions.
View Article Sources
- IRA and 401(k) Overview – State of Michigan
- 401(k) limit increases to $22,500 for 2023, IRA limit rises to $6,500 – IRS.gov
- How to Calculate Your Adjusted Gross Income – SuperMoney
- Roth IRA Contribution Limits for 2023 & How to Get Around The Roth IRA Income Limit – SuperMoney
- 401(k) Contribution Limits for 2023 – SuperMoney
- Can you have both a Roth IRA and Traditional IRA? – SuperMoney
- Ultimate Guide to Roth IRAs – SuperMoney
- How Many IRAs Can You Have? – SuperMoney