Retirement savings are a critical part of any financial planning strategy. Two popular types of retirement accounts are 401(k)s and IRAs. Both offer advantages and special considerations, leaving many investors wondering whether they can contribute to both at once.
In this article, we’ll answer the question, “Can you contribute to a 401(k) and an IRA at the same time?” In the process, we’ll take a closer look at the differences and similarities between IRAs and 401(k) accounts.
Understanding 401(k) and IRA Retirement Accounts
Before we delve into whether you can contribute to both accounts simultaneously, let’s understand what 401(k) and IRA accounts are. Retirement accounts are an essential tool for anyone looking to secure their financial future. With the right retirement account and investment strategy, you can save money on taxes, grow your wealth, and hopefully enjoy a comfortable retirement.
What Is a 401(k)?
A 401(k) plan is a retirement account that allows employees to set aside money for their future directly from their paycheck.
There are two types of 401(k) account: Traditional 401(k)s (most often referred to as just “401(k)s”) and Roth 401(k)s. Both allow your money to grow tax-free over time; however, they differ in some ways.
Contributions to a 401(k) account are tax-deferred, meaning earnings will not be treated as current income for federal tax purposes. In other words, you won’t pay taxes until you withdraw the money from your account. As a result, you can reduce your taxable income by contributing to a 401(k), which can save you money on current taxes.
A Roth 401(k), on the other hand, is not tax-deferred, meaning that contributions will not reduce your taxable income. However, unlike with a traditional 401(k), withdrawals from a Roth account are tax-free. That is, as long as you wait until you’re eligible to take distributions without penalty.
In addition to the tax advantages, there’s another significant upside to 401(k) accounts: Employer contribution matching. Though not required by law, many employers will match your contributions up to a certain amount or percentage.
What Is an IRA?
An individual retirement account (IRA), is a retirement savings account that is not tied to your employer. You can open one at a bank, broker, or financial institution.
Contributions to a traditional IRA account are tax-deductible. Alternatively, Roth IRAs are not tax-deductible but offer tax-free withdrawals in retirement (assuming certain qualifying conditions are met). Additionally, Roth IRA holders can withdraw contributions (not gains) at any time, with some exceptions.
One of the significant benefits of an IRA account is that you have more control over your investments. With a 401(k) account, your employer selects the investment options that are available to you. Typically, your choices are limited to your intended time horizon and risk appetite. Plus, you have to pay a plan administrator a fee for the management of your 401(k) portfolio, which will eat into your account growth over time.
With an IRA account, you can choose from a wide range of investment options. These include not just stocks, bonds, mutual funds, and exchange-traded funds (ETFs), but also alternative investments. Alternatives are assets that exist outside of the public markets and include startups, real estate, farmland, art, and even crypto.
Also unique to an IRA is that you can contribute regardless of whether your employer offers a 401(k) or other plan. This means those who are self-employed can set aside funds for retirement as well. The self-employed might also consider options such as a SEP IRA, though that’s a topic for another day.
Read more: SEP IRAs vs. 401(k)s: Which Is Right for Your Small Business?
Key Differences Between 401(k) and IRA Accounts
While both 401(k) and IRA accounts offer tax advantages and investment options, there are several key differences between the two:
- 401(k) accounts are typically employer-sponsored, while IRAs are individual accounts.
- 401(k) accounts have higher contribution limits than IRAs.
- Some 401(k)s offer employer matching contributions, which is not available with IRAs.
- IRAs offer more investment options than a typical 401(k) account.
When deciding which retirement account to choose, it’s essential to consider your individual needs and circumstances.
If your employer offers a 401(k) account with matching contributions, it’s usually a good idea to take advantage of it. On the other hand, if your employer doesn’t offer a retirement plan, an IRA could be your best option.
However, as you’ll soon discover, the best option—if available—could be to contribute to both a 401(k) and an IRA.
Whatever the case, it’s essential to start saving for retirement as soon as possible. The earlier you start saving, the more time your money has to grow.
Contribution Limits for 401(k) and IRA Accounts
Both 401(k)s and IRAs offer tax advantages and a way to save for the future, but they have different contribution limits and rules.
401(k) Contribution Limits
The 2023 annual contribution limit for 401(k) accounts is $22,500. However, if you are 50 or older, you are eligible to make an additional $7,500 catch-up contribution, for a total of $30,000 in 2023.
As we’ve already mentioned, employers may also offer a contribution match to your 401(k) account. Typically, this is up to a certain dollar amount or percent of your contributions. For 2023, the total combined contribution from both you and your employer cannot exceed $66,000 ($73,500 for those 50 or older).
IRA Contribution Limits
Individual retirement accounts (IRAs) also have contribution limits.
In 2023, the contribution limit for IRAs is $6,500. However, those 50 and older are eligible for catch-up contributions. The catch-up contribution limit for IRAs is $1,000. This means that if you are over 50, you can contribute up to $7,500 to your IRA account in 2023.
It’s important to note that there are income restrictions for contributing to a Roth IRA. Depending on your income, and that of your spouse (if married), you may not be eligible to contribute to a Roth IRA.
Read more: Am I Eligible for a Roth IRA?
Benefits of Contributing to Both a 401(k) and an IRA
So far, we’ve established what 401(k) and IRA accounts are, along with how much you can contribute to each. We also mentioned that the best strategy could be to contribute to both a 401(k) and an IRA.
Here, we’ll look at the benefits of contributing to both accounts simultaneously.
Diversifying Your Retirement Savings
Contributing to both accounts allows you to diversify your retirement savings. 401(k) accounts are often invested in mutual funds or other pooled investments, while IRAs offer a broader range of investment options.
With this in mind, one strategy might be to rely on your 401(k) for investments in traditional assets while using your IRA dollars to invest in alternative assets.
By contributing to both accounts, you can diversify your investments and potentially increase risk-adjusted returns.
Read more: Could These Alternative Assets Be the Best Non-Stock Investments?
Taking Advantage of Tax Advantages
Both accounts offer unique tax advantages.
Contributions to a 401(k) account are tax-deferred, while IRA contributions may be tax-deductible depending on your income level. Roth 401(k)s and Roth IRAs, on the other hand, offer tax-free withdrawals in retirement.
Maximizing Yearly Contributions
By maxing out your 401(k) and an IRA contribution, you can set aside more money for retirement each year.
Keep in mind that many employers match employee 401(k) contributions up to a certain percentage or dollar amount. For this reason, financial advisors often refer to this as “free money.”
Contributing to both accounts lets you not only contribute more, but also reap the benefits of employer matching contributions and greater portfolio diversification.
Considerations when Contributing to Both Accounts
While contributing to both accounts offers many benefits, there are a few considerations to be aware of.
Managing Multiple Accounts
Contributing to both accounts means you’ll need to manage multiple accounts and passwords.
Limiting IRA Tax Deductibility
Depending on your income or 401(k) contributions, you may not be able to write off traditional IRA contributions on your taxes. On the other hand, you might choose to hold both traditional and Roth accounts as part of your retirement tax strategy.
Read more: Are IRA Contributions Tax-Deductible?
Potentially Paying Penalties for Excess Contributions
If you exceed the contribution limits for either account, you could incur penalties and fees. This could also limit your ability to make contributions in future years.
That said, by contributing to both an IRA and a 401(k), you’re able to set aside more each year than you would with just one or the other.
Should You Contribute to a 401(k) and IRA?
Contributing to a 401(k) and an IRA account simultaneously can offer many benefits. Most notably, these include diversifying your investments, maximizing employer matching contributions, and taking advantage of unique tax benefits.
However, managing multiple accounts and the potential drawbacks of exceeding contribution limits and income limits for IRA deductibility should be considered.
If you’re unsure, consult with a trusted financial or tax advisor to determine the best retirement-saving strategy for you.
Want to diversify your portfolio? Open an account with Alto and invest in art, startups, crypto, and more using your IRA.
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