Written by: James Fox
IRAs and 401ks are the two most popular retirement accounts that people will save into for retirement. But, despite their popularity, I am commonly asked, “Can I contribute to a 401k and IRA?” While the short answer is yes, we should first dive into some basics regarding both IRAs and 401ks, as it is sometimes not ideal to contribute to both at the same time.
Is an IRA the same as a 401k?
From a limited tax perspective, yes. They are both pre-tax retirement accounts where you receive a tax deduction when you make contributions, should your income be below the IRA phase out. They are both are going to be subject to ordinary income taxes in retirement. Both 401ks and IRAs are tax deferred retirement accounts.
What is a Tax-Deferred Retirement Account?
A tax deferred retirement account is an account that will delay any taxes due on the balance of the account until distribution or withdrawal. The reason you would use a tax deferred retirement account would be to reduce your taxable income in any given year. Inside of a tax deferred retirement account, you avoid the tax burden from capital gains that you would otherwise experience in brokerage account.
What is the difference between a 401k and IRA?
Outside of the tax similarities, 401ks and IRAs do differ a bit. A 401k is an employer retirement account, where an IRA is an Individual Retirement Account. An IRA has a contribution limit of $6,000 plus $1,000 catch up contribution if over the age 50 in 2022, where the 401k has an employee maximum contribution of $20,500 plus an additional $6,500 for catch up contributions in 2022.
Additionally, a 401k would be established by your employer. They will select the investment options you can choose from. They will also administer the contribution through a salary deduction from your paycheck. On the other hand, IRAs would be set up individually, the investment options would be limited by where you set up the account and last the contributions would be made from your primary checking or savings account.
How many IRAs can you have?
There is no limit on how many IRAs you can have, in fact, you could open a new IRA for every contribution you make. I wouldn’t recommend that due to the logistical nightmare it would cause, but it is an option. A common question that follows, is how many retirement accounts can I have? Again, you are not limited to the number of retirement accounts you can have, however it can be beneficial to consolidate your accounts to keep better track of them.
What is the difference between an IRA, and Roth IRA?
IRAs are pre-tax retirement accounts, where you receive a tax deduction upon your contribution as long as your income is below the phase out. The money grows tax deferred inside of the account. When you withdrawal from the account after age 59 and a half, you will have pay ordinary income taxes on the full amount you withdraw.
A Roth IRA, on the other hand, is a post-tax retirement account. The contributions made do not receive a tax deduction. The money still grows tax deferred, but upon withdrawal at age 59.5 there will be no taxes due on the amount you withdraw.
Can I contribute to an IRA and Roth IRA?
Assuming that your income is below the phase out for Roth IRA contributions, yes. You are able to contribute to both at the same time. However, you are still limited to the annual IRA contribution limit of $6,000 plus $1,000 catch up contribution, despite contributing to both accounts.
Can I contribute to both a 401k and IRA?
Again, the short answer is yes. However, there may be some limitations. One limitation could be that you may not be able to take the deduction on the IRA contribution depending on your household income.
Secondly, choosing to contribute to an IRA alongside your 401k would be adding to your future tax burden in retirement. This would increase the tax sensitivity risk of your retirement income since both are pre-tax retirement accounts.
Instead, you might ask should I have a 401k and a Roth IRA? And that answer for a lot of people is, yes, as long as you are able to contribute should your income be below the IRS phase-out.
Making contributions to both 401ks and IRAs is permittable with certain limitations and can be a good way to increase your retirement savings. However, there are more considerations than just can I contribute to a 401k and IRA? You want to be aware of the tax treatment of your retirement income, the liquidity of your retirement funds, and if your income allows for deductions on your IRA contributions. All of these considerations need to be addressed and discussed with your financial professional before determining the best option for yourself.
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Investing involves the risk of loss, including total loss of principal. This should not be construed as individualized investing advice. Consult with your investment advisor to develop an appropriate investment strategy for your circumstances. This should not be construed as individual tax advice. Consult with your tax professional for specific tax ramifications for your circumstances.