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By Jenn Pavlick
Updated on June 6, 2024
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Yes, it is possible to have both a 401(k) and an IRA, and doing so can provide you with numerous benefits for your retirement savings. Both retirement plans impact your taxable income and, thus, your tax return, but there are some rules and limitations to remember.
In this article, we’ll dive into everything you need to know about managing both accounts, the factors you’ll need to consider, and the benefits they bring.
There are different types of retirement accounts, each with unique features and benefits. Understanding the differences between these accounts is essential when planning for retirement. This section will provide an overview of 401(k)s and two types of IRAs (Individual Retirement Accounts): traditional and Roth retirement plans.
A traditional 401(k) retirement plan is an employer-sponsored retirement account that allows employees to contribute a portion of their salary on a pre-tax basis. Employers often offer matching contributions up to a specified percentage of compensation, and the IRS sets annual contribution limits. For 2023, the limit is $22,500, with a $7,500 catch-up contribution for individuals 50 and over.
Investments within a 401(k) account grow tax-deferred, meaning you’ll pay taxes upon withdrawal during retirement. Some employers even offer Roth 401(k) options, which allow for after-tax contributions.
One of the main benefits of a traditional 401(k) is that your contributions count as deductions for income tax purposes and can help lower your tax bracket in the year of contribution. Account holders are required to take distributions beginning at age 73 (as of 2023, though this age is constantly changing!)
A traditional IRA is an Individual Retirement Account that allows individuals to contribute up to $6,500 annually, as of 2023, with $1,000 available in catch-up contributions for those 50 and over.
Traditional IRAs have the potential for tax-deductible contributions, like traditional 401(k)s, based on income and other employer-sponsored retirement plan coverage. Investments within a traditional IRA grow tax-deferred, and taxes are due upon withdrawal during retirement.
Traditional IRAs also mandate Required Minimum Distributions (RMDs) starting at age 73.
A Roth IRA is an Individual Retirement Account that allows earners to contribute a certain amount annually with after-tax dollars. There are income limits for eligibility to contribute directly to a Roth IRA (for 2023, the phase-out limit is $153,000 for a single filer and $228,000 for those married filing jointly). Investments within a Roth IRA grow tax-free, and withdrawals during retirement are also tax-free, provided certain conditions are met.
Unlike traditional IRAs, there are no Required Minimum Distributions (RMDs) for Roth IRAs, so they can be used as long-term investment accounts that can potentially be left for beneficiaries.
Roth IRAs have the same contribution limits and catch-up contributions as traditional IRAs.
The IRS sets specific rules and limits for contributing to both a 401(k) and an IRA to ensure individuals don’t take advantage of tax deductions using their brokerage accounts and retirement plans or IRA contributions. Understanding these thresholds and limits is essential to avoid penalties and maximize retirement savings.
There are income limits for contributing to a Roth IRA and deduction limits for traditional IRA contributions. Income limits for Roth IRA contributions depend on your filing status, and there is a phase-out range for partial contributions.
In 2023, the Roth IRA contribution limits are:
Income limits for traditional IRA deductions are based on your filing status and whether you’re covered by an employer-sponsored retirement plan in addition to your IRA. There are also phase-out ranges for partial deductions.
The IRS provides up-to-date information as to whether or not you will receive a deduction for your traditional IRA contributions.
In 2023, the deduction limits for contributing to a traditional IRA if you’re also in an employer-sponsored plan are as follows:
Your Modified Adjusted Gross Income (MAGI) and filing status affect eligibility for IRA contributions and deductions. MAGI is calculated by adding certain deductions to your adjusted gross income (AGI) on your tax return.
Different filing statuses, such as single, married filing jointly, and married filing separately, affect IRA eligibility, as we showed above.
The annual contribution limits for a 401(k) include catch-up contributions for individuals aged 50 and older. Employer matching contributions do not count toward the individual’s annual limit.
In 2023, the individual contribution limit for a traditional 401(k) is $22,500, with a $7,500 catch-up contribution for those 50 and over.
The total annual contribution limit for 401(k)s, including both employer and employee contributions, is $66,000. Catch-up contributions would allow for another $7,500, bringing the annual contribution limit for someone 50 or over to $73,500.
There are distinct advantages to contributing to both a 401(k) and an IRA. Combining the two types of accounts can help individuals take advantage of tax benefits, maximize their investment options, and build up their retirement savings.
Contributing to both types of accounts can provide tax advantages. Recall that you can make pre-tax contributions to a 401(k) and traditional IRA, and after-tax contributions to a Roth IRA. The right choice for you depends on your total financial circumstances, as well as your projected tax rate in retirement.
Additionally, Roth IRAs offer the potential for tax-free withdrawals in retirement. On the other hand, 401(k)s and traditional IRAs grow tax-deferred; contributing to either account can provide current-year tax breaks by reducing your earned income for the year.
Having both a 401(k) and IRA allows for greater diversification in investment options, which can positively impact your retirement savings. Many investment options are available across 401(k) and IRA accounts, including stocks, bonds, mutual funds, and more. Diversification can help manage risk and potentially improve long-term returns, all while mitigating market volatility.
Maximizing employer matching contributions in a 401(k) plan is crucial; so much so, in fact, that some savers refer to the employer match as “free money.”
Employer matching typically involves the company contributing a certain percentage of your 401(k) contributions, up to a specified percentage of your salary. A general rule of thumb around this is to contribute at least enough to your 401(k) to receive the full employer match before considering IRA contributions.
Contributing to both a 401(k) and an IRA offers numerous benefits and opportunities to maximize your retirement savings, diversify your investments, and take advantage of tax-advantaged growth.
Understanding the rules and limitations is key to avoiding penalties and making the most of your retirement accounts. Remember that the opportunities for deductions and contributions may be limited depending on your income and whether you have an employer-sponsored plan at your job.
If you want to take control of your old retirement savings, think about partnering with a trusted professional service like Capitalize. We can help you find your old 401(k) accounts and execute rollovers seamlessly.
Start planning for your future today by working with our team of experts.
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