Can I Contribute To A 401k And An IRA?

in Retirement Planning by

This question about comes up frequently:  can I contribute to a 401k and an IRA? Fortunately for your retirement nest egg, you can contribute to both types of retirement accounts. In fact, both workplace and individual retirement accounts represent important building blocks in building your retirement savings. Supplementing your workplace retirement account is a great way to boost your retirement savings and put even more of your money to work in tax-advantaged accounts.

An added bonus: IRAs also often offer more investment options than the typical 401k plan. Just as with your traditional 401k, you contribute pretax dollars to a traditional IRA (as I discuss further, you can only contribute pretax dollars up to certain income levels) and then benefit from tax-deferred growth and distributions.

Contribution Limits For A 401k And An IRA

While contributing to both a 401k and IRA is certainly allowed, there are a few considerations to keep in mind. The first is the contribution limits the IRS places on each type of account, which are outlined in the table below.

table2

Remember that contribution limits apply to the total of your contributions to all of your retirement accounts, either IRA or 401k. Note that the chart below includes the Roth option – which as of 2006 has been available for 401ks as well as IRAs.  To read about how to decide between a Roth and a traditional account, see the Personal Capital blog post on “going Roth.”

Paying attention to these limits is important. If you do contribute more to your IRA accounts than is allowed, you’ll face a penalty in the form of a 6% tax on the excess contributions for each year they remain in the account. Putting too much into a 401k is unlikely because most plan administrators won’t allow it. However, if it does happen, you have until April 15th of the following year to remove the excess funds. If you miss that deadline, you’ll essentially be taxed twice on that money – once when you contribute it, and then you’ll pay tax on those funds again when you withdraw them.

IRA Deduction Limits

If you save with both a 401k and a traditional IRA, you may also face some limits on your ability to deduct your contributions depending on your income. Contributions to a Roth are never deductible.

For instance, if you are covered by a retirement plan at work:

  • You can deduct up to the contribution limit, if you’re single and your modified AGI is $60,000. And you can take a partial deduction if your income is between $60,000 and $70,000. There’s no deduction for people who earn more.
  • If you’re married and filing jointly, you can deduct the full amount if your modified AGI is $96,000 or less. You can take a partial deduction if your income is between that and $116,000. There’s not deduction if you earn more.

Deducting your contributions is always an added bonus, but keep in mind even if you’re above the limit that you’re still reaping the rewards of the IRA’s tax-deferred growth.

Examples Of How You Can Contribute To Both A 401k And An IRA

Let’s look at an example of how you can combine the power of the 401ks and IRAs to speed up your retirement savings:

Example #1: Consider a 30-year-old earning $55,000 per year (25% tax bracket). Her first priority should be saving at least enough in her workplace retirement plan to earn the full employer match, which in her case is 50% of the first 6% saved (a typical match scenario).

In this case, she’s saving nearly $5,000 in tax-deferred funds in her 401k ($3,300 + $1,650 match). However, perhaps she’s anticipating earning far more in the near future and wants to sock away some after-tax money while she’s still in a relatively low tax bracket. She could save an additional $5,500 in a traditional IRA. That brings her total annual contributions to $10,500, all of it growing in tax-advantaged accounts.

Example #2: Consider a 23-year-old at the beginning of her career who only makes $35,000 a year. She contributes 5% of her gross salary into a 401k ($1,750) and receives a one-for-one match up to $5,000. At the end of the year, she gets a $3,000 bonus and decides to also contribute to a Roth IRA instead of a traditional IRA or a 401k for tax diversification purposes.

She speaks to her mentor who mentions that because she’s only in the 15% tax bracket, it’s better to contribute to a Roth IRA and pay taxes up front, rather than differ paying taxes until she is 59.5 because she could very well be in a higher tax bracket. In total, she saves $3,500 in her 401k and $3,000 in her Roth IRA.

Example #3: Finally, consider a married 55-year-old man earning $280,000 per year. Say he’s maxing out his workplace 401k at his $17,500 yearly contribution limit. Because he’s over 50, he also gets to make a catch-up contribution of $5,500 to his 401k. Luckily for him, his work matches contributions one-for-one up to 6% of his salary – which means another $16,800 in his 401k, for a total of $39,800 that is pre-tax and will grow tax-free.

While he can also contribute $6,500 to a traditional IRA, his contributions will be nondeductible given his modified AGI level.  The savings will still grow tax-free, so he decides it’s still a worthwhile retirement savings vehicle to pursue, despite the fact that it’s tied up for the next 4.5 years.

Retirement Contributions Add Up Over Time

401k-FS-2014

Based on the above chart, you can see how one’s 401k savings can really start adding up over time. The low end assumes a consistent maximum contribution of $17,500 after the first year contribution of $8,000 with zero company match and zero growth. The high end column assumes a consistent maximum contribution of $17,500 plus a 5%-10% annual rate of return with zero company match.

So whether you’re looking for additional tax deductions or just a way to boost your savings, talk to your Personal Capital financial advisor about opening an IRA in addition to your workplace 401k. Once you retire, you’ll be glad you saved for all those years.

Welcome to Personal Capital

Photo credit: Steven Depolo

The following two tabs change content below.
Kelly Kearsley

Kelly Kearsley

Kelly Kearsley has been covering business and personal finance issues for more than a decade. Her work has appeared in several publications including WSJ.com and CNNMoney. She loves interviewing new people and sharing advice that helps people better their financial lives.

17 comments

  1. Financial Samurai

    One of my regrets was not contributing to an IRA back in 1999 when I had the chance. I viewed the $2,000 contribution amount to be not much back then, but savings is savings right?

    I’m disappointed the government caps the income limit at only $60,000 to provide tax free contribution to an IRA. You’d think that saving for retirement is a right for all, even those making $60,000. What about all those who live in expensive cities such as SF, NYC, and LA?

    Let’s make things more equal for everybody.

    Reply
  2. Alberto Grazi

    In case #3 it would be advisable to make a backdoor Roth IRA contribution by immediately convert the IRA to Roth IRA (which can be regardless of income levels and carries zero taxes as the IRA contribution was not deductible due to the high AGI)

    Reply
    • Financial Samurai

      Alberto,

      Can you expound on the backdoor ROTH IRA? We’ve had some discussions about it, and I’m not sold. You mention that a backdoor ROTH IRA “carries zero taxes.” Please explain as I thought the whole issue of conversion is for the government to make people convert to get your taxes up front.

      thx

      Reply
      • mark

        As Alberto mentioned, the backdoor is a way around the income limits on a roth ira. You first contribute post tax income to a regular ira. Then you convert it to a roth ira (or into an existing account). You will pay taxes on any gains (since an ira is taxable on withdrawal loke a 401k), but if you do this quickly you’ll have little to no additional taxes. Chaulk this up to the law of intended consequences as this was never meant to work this way, but it’s perfectly legit.

        Mark

        Reply
        • Anonymous

          Yes, but you’re just paying taxes on the contribution “now” rather than waiting ’til retirement.
          What difference does that make? Pay now, pay later. I’m 70, still have a substantial income from investments, and guess what. The government bases your social security payments on earned income, but they tax you on all your income. Nothing is fair about the way our government makes us pay. Then our elected officials go by a different set of rules.

          Reply
          • Stoyan Iordanov

            You’re paying the taxes now regardless, this us after-tax money anyway (assuming you’ve already maxed pretax options such as 401(k)).

            The difference is that, with the backdoor Roth, you’re saving yourself from having to pay tax on the future capital gains.

            It’s just one more way to save money on taxes, after having exhausted the obvious options.

    • Stoyan Iordanov

      +1. This is a great way for high-income earners to save.

      Here is how it works, if you want to save to the max:

      1. You max out your pre-tax 401(k). (Technically not required, but good practice anyway).
      2. You max out your after-tax 401(k).
      3. Immediately upon making the after-tax 401(k) contributions, you call your plan provider and request “in-plan conversion” of the after-tax portion. This could be either to a Roth IRA, or Roth 401(k), if your plan offers it.

      Even though this doesn’t save you from having to pay income taxes on the money to be contributed after-tax, it does allow it to grow tax-free from then on.

      Reply
  3. Barbara Friedberg

    Barbara Friedberg

    My husband and I have been contributing the max to workplace retirement accounts, IRA (or Roth IRA’s) and whatever tax deferred options are available. I currently also contribute the max to an HSA. We’ve sacrificed a lot to save and aggressively invest, and it has paid off.

    Reply
  4. SavvyFinancialLatina

    Very useful information. This year I’m planning to max out my 401K, ROTH IRA, and my husband’s traditional IRA.

    Reply
  5. Peter

    I did exactly what Stoyan mentioned. My question is, after doing all that, can I still make a non-deductible contribution (5500 for 2015) to a traditional IRA and do another backdoor conversion to Roth?

    Reply
  6. Ashish

    1) My age is 38 years
    a) I work for employer who contribute 50% of first 6% of my salary. My age is 38 years

    b) My wife (age 34 years) work in government job, government pension contribution and no 401k match.

    For 2015, 401k contribution limit being $18,000.00
    For 2015, Traditional IRA limit being $5,500.00

    Question-1: How much I can contribute in each account 401k & Traditional IRA?
    Question-2: How much my wife can contribute to 401k & Traditional IRA?

    Reply
  7. Anthony

    I have a 401k at work and do not max it out, Im 63 and have made catch up contributions to my personal IRA in the amount of 5K.
    Does the IRS allow that IRA catch up contribution to be used as a tax deduction?

    Reply
  8. nani reddy

    if i contributed to 401k and ira then can i claim both as deduction if it is possible what is my maximum amount of deduction

    Reply
  9. Jerry

    There’s something I don’t understand about example 3. If he’s fully maxed out his 401k and can’t take the deduction on the traditional IRA, isn’t this money already taxed? I thought the point of the traditional IRA was to reduce your taxable income while saving for retirement, as opposed to the Roth, on which you paid taxes now.

    How is the money growing tax free if he can’t take the deduction?

    Reply
    • Stoyan Iordanov

      It’s not obvious, but I think they might be referring to the backdoor Roth IRA, where he’d contribute noon-deductible to traditional IRA and then immediately roll them to Roth.

      Note, however, that this only works if he doesn’t already have an IRA. Otherwise the existing IRA would screw up the calculations on form 8606 and he’d be taxed again for the IRA distribution for the rollover transfer.

      Reply
  10. Retirement Plan Advisors

    Beginning a retirement reserve funds arrangement can be less demanding than most entrepreneurs might suspect. Besides, are various retirement programs that give charge points of interest to both managers and employees.401(k) plans have turned into a generally acknowledged retirement investment funds vehicle for little organizations. An expected 53 million U.S. laborers take part in 401(k) plans that have absolute resources of about $4 trillion.

    Reply
  11. Jeff

    IMO, the Roth IRA is a must have financial vehicle that everyone should utilize. Excellent chart, btw! A 401k is nice if you have a dependable employer, but aside from that, I would rather invest into other assets like real estate, art, gold, land and maybe even crypto currencies.

    Reply

Leave a Reply

Your email address will not be published.

Disclaimer. This communication and all data are for informational purposes only and do not constitute a recommendation to buy or sell securities. You should not rely on this information as the primary basis of your investment, financial, or tax planning decisions. You should consult your legal or tax professional regarding your specific situation. Third party data is obtained from sources believed to be reliable. However, PCAC cannot guarantee that data's currency, accuracy, timeliness, completeness or fitness for any particular purpose. Certain sections of this commentary may contain forward-looking statements that are based on our reasonable expectations, estimate, projections and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not a guarantee of future return, nor is it necessarily indicative of future performance. Keep in mind investing involves risk. The value of your investment will fluctuate over time and you may gain or lose money.