Can I contribute to both a 401k and an IRA?
Unfortunately, there is not a simple, direct answer to this frequently asked 401k question. Many people seek to maximize retirement savings by maintaining and contributing to multiple types of retirement accounts (including 401k’s and IRA’s). As a starting point it is important to have basic knowledge of the different types of IRA acounts and the eligibility rules governing them:
- Tax-deductible IRA – this is the original IRA allowing you to reduce taxable income by the amount of your contributions (within limits). Unfortunately, it is also the most complex type of IRA with convoluted eligibility requirements that depend on age, total income and whether or not you are covered by a 401k or other retirement plan at your place of work. It is possible for many workers to participate in both a 401k and a tax-deductible IRA at the same time, but the rules are complex, confusing and easy to get tripped on -especially for married persons. If you want to find out if you can contribute to both your 401k and a tax-deductible IRA, you’ll need to do considerable homework and/or consult a qualified tax advisor. This IRA Primer is a good starting point.
- Nondeductible IRA – this is the easiest IRA to understand. Anyone – regardless of age, income or whether or not you are covered by a retirement plan – is eligible to contribute, provided he or she has earned income at least equal to the amount of the IRA contribution.
- Roth IRA – There’s no tax deduction with Roth IRA’s. Instead, after-tax contributions are allowed to grow tax-free and withdrawals, subject to certain rules, are not taxed at all. Roth IRA’s are not available to higher earners (Single filers AGI must be below $120,000; married below $176,000).
So, you can have a 401k and an IRA at the same time provided you meet the requirements of the particular type of IRA you want. For typical middle-income 401k participants, the 401k-Roth IRA combination is likely the most sensible strategy for several reasons:
- Roth IRA’s are less retrictive than traditional IRA. For example there are no required minimum distribution rules with a Roth. This gives you added flexibility in retirement.
- Roth’s provide a hedge against higher tax rates in the future. 401k retirement withdrawals
will be taxed and there is no guarantee that you marginal tax rate in retirement will be lower than it is now. Roth withdrawals are not taxable.
- The 401k-Roth strategy allows you to maximize retirement savings.
One further strategy recommneded by some retirement planners is to first contribute to your 401k at a level adequate to max-out employer matching contributions, then contribute to a Roth IRA.
Use SmartMoney’s IRA options calculator to determine which IRA makes most sense for you.