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Can You Contribute to Both a 401(k) and an IRA at the Same Time?

Chances are you’ve heard of two popular types of retirement options: 401(k)s and IRAs.

And, that no matter whether you’re in the rookie or veteran stage of your career, it’s never too late to take advantage saving for retirement.

While it’s quite possible that your employer may have offered you both types of accounts, many employees choose just one to invest in, believing that you’re only allowed to pick one, not the other.

Unfortunately, doing so means believing one of the biggest retirement savings myths there is, severely limiting your savings potential.

The truth is that you may open — and contribute — to both types of retirement accounts simultaneously.

Before dividing up your hard-earned money into two separate retirement accounts, here’s all you need to know to get retirement ready:

401(k)s vs IRAs: What’s the Difference?

401(k)s and IRAs have a few noteworthy things in common. They’re both excellent ways to save for retirement. They both offer significant tax advantages. And, you can invest in both at the same time.

401(k)s are named after the tax code they’re based on, a retirement account that allows you to contribute a percentage of your paycheck without your automatic deposits being taxed.

Employer-sponsored, yours may elect to match your contributions up to a certain amount.

Many use the 6% standard, which means that they’ll deposit up to 6% of contributions you elect, effectively doubling your money just for having an account.

Invest at least the maximum your employer will match to get the most out of your 401(k).

401(k)

Traditional and Roth 401(k)s both come with tax breaks, but with a difference.

Contributions to a traditional 401(k) are taken out of pre-tax dollars, and you won’t be taxed until you start making withdrawals upon retirement.

With a Roth 401(k), your withdrawals aren’t subject to tax, but then, your contributions are taken out of post-tax, net earnings, significantly lessening your tax obligations before and after.

Traditional 401(k) vs. Roth 401(k)

Traditional 401(k) Roth IRA 401(k)
Contributions are tax-deductible. Contributions are not tax-deductible.
Pay taxes upon withdrawal. Earnings can be withdrawn tax-free and without penalties if the funds were in the Roth 401(k) for 5 years and you've reached age 59 1/2.
Required minimum distributions (RMDs) are required starting at age 70 1/2. Required minimum distributions (RMDs) are required starting at age 70 1/2.

IRAs

On the other end of the retirement savings spectrum, IRA stands for Individual Retirement Account, another tax-advantaged way to save for your post-career years.

IRAs are not employer-sponsored and a good alternative if yours doesn’t offer a 401(k).

Similar to a 401(k), there are two main types of IRAs offering their own tax perks.

The money you contribute toward a traditional IRA may be deductible from your income taxes; and with a Roth IRA (similar to a Roth 401(k)), your contributions are from post-tax dollars, so since you’ve been taxed once, you can’t be taxed again when it comes time to withdraw from your savings.

Traditional IRA Vs. Roth IRA

Traditional IRA Roth IRA
Contributions may be tax-deductible. Contributions are not tax-deductible.
Pay taxes upon withdrawal. Earnings can be withdrawn tax-free and without penalties if the funds were in the Roth IRA for 5 years and you've reached age 59 1/2.
You must be under age 70 1/2 to contribute. You can contribute at any age.
Required minimum distributions (RMDs) are required starting at age 70 1/2. No RMDs required.

Contributions

Typically, to be eligible to participate in a 401(k), you’ll need to be at least 21 years old and have worked for your employer for one year, but those rules have started to go away, as many employers offer their sponsored retirement plans immediately upon hire.

In 2018, the maximum you can contribute to a 401(k) is $18,500 for the entire year, $500 up from 2017.

The good news is that if you leave your place of employment, the money you’ve saved is yours to roll over into another account, either your own private IRA, or another 401(k).

You can contribute to a Traditional IRA at any age, up to age 70 and a half.

If you’re under 50, your annual contribution limit is $5,500; if you’re over 50, you can make a one-time, annual catch-up contribution of $1,000 every year, for a $6,500 limit.

Contributions to a Roth IRA are based on your annual gross income.

In 2018, if you’re filing your taxes as a single person, you can contribute up to the same limit as a Traditional IRA ($5,500 annual, $6,500 annual for account holders age 50 or older) if your income is less than $120,000.

If your income is equal to or greater than $120,000, but less than $135,000, you can contribute a reduced amount, and if you earn $135,000 or more, you can’t contribute to a Roth IRA.

The Case for Contributing to Both

Dispersing your retirement savings in both a 401(k) and an IRA is entirely to your benefit, if for any other reason than you shouldn’t have to limit yourself to one type of account when you don’t have to.

Consider some of the other advantages of investing in both:

Tax savings

Right off the bat, contributions to 401(k)s and IRAs grow tax-free, eliminating your tax obligations in the years you’re saving up.

Both accounts balance each other out; while 401(k) withdrawals are taxed, contributions are not.

And, Roth IRA withdrawals are not taxed since your contributions are already from post-tax dollars.

Meeting with a financial advisor to develop a retirement savings strategy can maximize your contribution limits to a 401(k) and IRA simultaneously.

For instance, if you’re early in your career and expecting to earn a higher salary in future years, socking away money in an IRA now — while your income eligibility requirements are lower — is a good supplement to investing in your employer’s 401(k).

And, you get the tax benefits of both. Year over year, your savings compound.

Savings for the future: Statistics maintain that you should try to replace between 70 to 90 percent of your income to maintain your current lifestyle in retirement — but don’t rely on Social Security to get you through it alone.

Social Security is only meant to replace 40 percent of your income, making the need for one or more retirement savings account absolutely necessary to save for the future.

Free money

What could be better than getting an employer match just for having a 401(k)?

Aim to contribute as much as you can to receive their full matching amount.

If you’re unsure about your workplace’s contribution rules, consult with your human resources or finance department.

Flexibility

By and large, you’ll get the most flexibility from investing in an IRA.

Whereas 401(k)s may carry restrictions on where the money can be invested according to your employer’s plan structure, an IRA is private, and you can determine where to best invest your contributions for maximum return.

IRA fees may also be lower depending and how and where you make your investments.

Plus, they provide an added level of retirement security whether you invest in one type of retirement fund or more.

Restrictions

Be careful of penalties and other fees that can reduce your hard-saved earnings. Withdrawals made from a 401(k) before the age of 59 and a half are subject to a 10 percent penalty tax.

Say you withdrew $5,000. That’s a $500 penalty.

Make too many such early withdrawals, and the fees can add up more than you deserve.

Part of the reason for this penalty is because 401(k) withdrawals, not contributions, are taxable, essentially making a penalty fee a tax on top of a tax.

Early IRA withdrawals are also subject to the same penalty, but they’re allowed if you use the money towards a qualified expense, such as using your funds to pay for medical premiums after losing a job, higher education costs, a first-time home purchase, or buying an annuity.

When Your Employer Doesn’t Offer a Retirement Account

It’s not uncommon to see many businesses that don’t offer a 401(k) plan.

Many newer startups or smaller companies, for example, might not have the financial capital yet to offer a plan to their employees.

If that’s the case with you, or, if you’re self-employed and flying the freelance flag, don’t worry: you can still save for a lucrative, full retirement.

Of course, your first and best option is a Traditional or Roth IRA.

IRAs are great for those with low incomes (or independent contractors in down periods of the year), since you may qualify for a saver’s credit, up to $1,000 back on your taxes, and up to a $2,000 contribution match depending on your level of income.

Generally, if you file an income no higher than $19,000 in the tax year, you’re eligible for up to a 50 percent IRA contribution match.

Your other retirement savings options when no 401(k) is available? Try investing money in one of many other options, including:

  • a taxable brokerage account
  • a Coverdell or 529 account
  • savings plans with tax-free distributions when used for qualifying education expenses
  • an online savings account, preferably one with a high-yield interest rate.
  • a CD (or laddering your savings in a series of certificates)

Conclusion

Saving for your retirement, even if it’s 20, 30, 40, or even 50 years away, is a smart start to building a savings foundation.

Do you your best to max out your savings for retirement, especially if it’s in taking advantage of an employer match.

Feel like you’re already spreading your dollars too thin?

Start retooling your budget, and see where you can trim expenses and free up extra money to increase your contributions.

But also be mindful of putting your eggs in one basket. Saving for tomorrow is important, but not at the expense of money you need for today.

Remember to devote money to other important expenses to use now before anything, like student loans, car or mortgage payments, or setting up an emergency fund — ideally three to six months’ of living expenses.

Out of what money remains, select a comfortable percentage to contribute to your retirement plans. You can always increase your contribution amounts as you begin to earn more, or your financial situation changes.