If you’ve ever wondered Can I contribute to an IRA and a 401k plan at the same time, the good news in general is that the answer is “yes”. (But keep in mind there will be some possible restrictions to note below.)
The first thing you need to understand in working your way through this question is that an IRA and 401k are two separate and unique savings tools. Both were designed and intended to help you grow your overall retirement nest egg. But there are some fundamental differences to understand between the two types of plans.
401k plans are offered and handled by your employer. They decide what financial institution the plan will be setup through, what kinds of funds they want to offer, setup the automatic transactions from your paycheck, etc. All you, the participant, has to do is simply decide how much money you wish to save (up to the 2015 maximum allowable IRS limit of $18,000 per year or $24,000 if you’re age 50 and older).
An IRA, on the other hand, is a retirement account that you setup and control yourself. You pick the investment firm, what funds you’d like to invest in, and personally handle all the transactions. In 2015 you can save up to $5,500 per year or $6,500 if you’re age 50 and older.
Exceptions When You Can’t Contribute to an IRA and a 401k:
There are a few rules to be aware of that may prevent you (or your spouse) from fully contributing or even maxing out both an IRA and 401k. The main contributing factors will mostly have to do with your adjusted gross income (AGI) and what your tax filing status is.
To start, there are no income restrictions that will prevent you from being able to contribute to a 401k plan if your employer offers one. It does not matter if you make $50,000 or $500,000; you can still contribute as much as you want to your 401k plan (up to the IRS contribution limits). The only technical restriction is whether or not you qualify as something called a highly-compensated employee or HCE. That qualification is dependent on a number of very specific variables about your employer such as how many people work at the company, what the income distribution is like, etc. For the majority of middle-class citizens, this restriction likely won’t apply.
With that said, you then must consider what your AGI is for the year in order to determine if you can also contribute to an IRA fund. The rules are different whether you plan to contribute to a Traditional IRA or Roth IRA.
If you plan to contribute to a Roth IRA but exceed these AGI limits, then you won’t be able to save your money in a Roth IRA for that year.
For the Traditional IRA, it’s a little different. You can always save your money in a Traditional IRA. But whether or not you’ll get the tax deduction benefit of using it is another story. Again, that will be based on your AGI as follows:
In my opinion getting that awesome tax deduction is really one of the main, critical benefits of even contributing to an IRA. So whether or not you qualify to take it may certainly have an impact on your decision to participate with a Traditional IRA or simply invest in something else.
To help put these subtle rules in perspective, let’s look at a few common examples to how this would all play out.
You and your spouse file a joint income tax and have an AGI of $90,000. That means you can fully participate in both a 401k and an IRA (either a Roth or Traditional with full tax-deduction).
You and your spouse file a joint income tax and have an AGI of $150,000. That means you can fully participate in a 401k and Roth IRA. If you preferred you could use a Traditional IRA instead of a Roth IRA, but you would not be eligible to take the tax-deduction against your filing (which would probably make it the less desirable choice against the Roth).
You and your spouse file a joint income tax and have an AGI of $250,000. You’ll be able to contribute to the 401k plan, but you won’t be eligible to contribute to a Roth IRA. You could still use a Traditional IRA if you wanted, but again you would not be eligible to take the tax-deduction against your filing.
Use Both an IRA and 401k to Your Full Advantage:
Whenever possible I always like to encourage everyone (to the extent that the IRS allows) to contribute to both their IRA and 401k plans. Every dollar you save in a retirement plan is an opportunity to defer paying taxes and grow your nest egg tax-free. Free financial software like this one offered by Personal Capital make it very simple to link your accounts to one central place where you can track and monitor your progress.
Beyond simply growing the biggest fortune you can, if you dig a little deeper you’ll also find that diversifying some of your retirement savings into a 401k and some into an IRA can actually help shape your finances in more ways than one. For example, consider the following:
- Beyond the point of receiving your full employer 401k matching contribution, you may find it cheaper to hold some of your savings in a low cost IRA rather than in the more traditionally expensive 401k plan funds.
- Putting some of your money into a Roth IRA will help reduce your tax bill when you finally retire.
- Holding some of your money in an IRA outside your 401k plan can also give you more diversification over what kinds of assets you can invest in.
If you’re interested in some general advice on how to structure your 401k and IRA savings habits, check out this helpful post we wrote here.
Images courtesy of FreeDigitalPhotos.net and the IRS