401(k) & IRA: Can You Contribute to Both?

It is a question that comes up frequently when it comes to retirement planning: Can I contribute to a 401k and an IRA? The simple answer is yes, you can. However, there are some caveats when it comes to deducting your IRA contributions if you participate in both types of plans.

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 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 may contribute pretax dollars to a traditional IRA and then benefit from tax-deferred growth and distributions. As I later cover, be aware that you can only contribute pretax dollars up to certain income levels.

Read More: When is the IRA Contribution Deadline?

401k and IRA Contributions Limits for 2021

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.

Contributions

Account Type Contributions Traditional IRA Frequently made with pre-tax dollars. Can contribute up to $6,000 in 2021 ($7,000 if you are age 50 or older).* Roth IRA Made with already taxed dollars. Can contribute up to $6,000 in 2021 ($7,000 if you are age 50 or older).* Traditional 401k Made with pre-tax dollars. Can contribute up to $19,500 in 2021. If you are over age 50, you may contribute up to an additional $6,500/year. Roth 401k Made with already taxed dollars. Can contribute up to $19,500 in 2021. If you are over age 50, you may contribute up to an additional $6,500/year.

Eligibility

Account Type Eligibility Traditional IRA Anyone can participate, but you must have earned income. The SECURE Act, passed in December 2019, allows traditional IRA owners to keep making contributions indefinitely. Roth IRA Contributions can be made at any age, and you must have earned income. There are eligibility restrictions based on your filing status and income. Learn about these restrictions here. Traditional 401k You must work for an employer that provides a 401k. Roth 401k You must work for an employer that provides a Roth 401k. There are no income limits like a Roth IRA has.

Taxes on Withdrawals

Account Type Taxes on Withdrawals Traditional IRA Assuming an individual received a tax deduction for each contribution, all withdrawals are taxed at federal and state income tax rates. In 2020, IRA owners impacted by the coronavirus were able to take tax-favored distributions up to $100,000. The withdrawal must be paid back within 3 years to avoid federal income tax consequences. Roth IRA None for qualified distributions. Traditional 401k All withdrawals are taxed at federal and state income tax rates. In 2020, the CARES Act allowed retirement savers to take 10% or up to $100,000 out of their 401k plans for coronavirus-related reasons and pay taxes over 3 years. Roth 401k None for qualified distributions.

Penalties

Account Type Penalties Traditional IRA 10% penalty on withdrawals made before age 59 ½. There are some exceptions. Roth IRA 10% penalty on withdrawals of investment earnings made before age 59 1/2, with a few exceptions. You can generally withdraw your contributions at any time. Traditional 401k 10% penalty on withdrawals made before age 59 ½. There are some exceptions. Roth 401k 10% penalty on withdrawals of earning made before age 59 1/2, with a few exceptions. You can generally withdraw your contributions at any time.

Required Minimum Distributions

Account Type RMDs Traditional IRA Must take RMDs April 1 of the year following the calendar year in which you reach age 70½, if you were born before July 1, 1949. If you were born after June 30, 1949 then you must take RMDs April 1 of the year following the calendar year in which you reach age 72. Roth IRA None during your lifetime. Traditional 401k Generally, April 1 following the later of the calendar year in which you reach age 72 (age 70½ if born before July 1, 1949) OR retire (if your plan allows this). Roth 401k RMDs must begin by age 72 (or 70½ if you reached that age by January 1, 2021.) If you’re still working, you don’t have to take RMDs.

* The IRA contribution limit does not apply to:

• Rollover contributions
• Qualified reservist repayments

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 above includes the Roth option – which has been available for 401ks and IRAs since 2006.

Paying attention to these limits is important. If you do contribute more to your IRA accounts than is allowed (this frequently happens for individuals making Roth contributions), you’ll face a penalty in the form of a tax on the excess contributions for each year they remain in the account.

Putting too much into a 401k happens from time to time, especially for those that change jobs throughout the year, but occurs rarely if you were fully employed at only one company for all twelve months, as most plan administrators won’t allow it.

Thankfully, if either of the situations occur, you have until April 15th of the following year to remove the excess funds.

If you miss that deadline, you should work with a CPA to calculate any tax liability.

IRA Deduction Limits for 2021

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 $66,000 or less for 2021. You can take a partial deduction if your income is between $66,000 and $76,000 in 2021. There’s no deduction for people who earn more than $76,000 in 2021.
• If you’re married and filing jointly, you can deduct the full amount if your modified AGI is $105,000 or less in 2021. You can take a partial deduction if your income is between $105,000 and $125,000 in 2021. There’s no deduction if you earn more than $125,000 in 2021.

Deducting your contributions is always an added bonus, but keep in mind even that if you’re above the limit to make a contribution and reduce your taxes, there are alternative and potentially better strategies to explore than the nondeductible Traditional IRA.

Examples of How You Can Contribute to Both Plans

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. 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 $6,000 in a Roth IRA. That brings her total annual contributions to $10,500, all of it growing in tax-advantaged accounts.

Example #2: Next, consider a married 55-year-old woman earning $300,000 per year. Say she’s maxing out her workplace 401k at her $19,500 yearly contribution limit. Because she’s over 50, she also gets to make a catch-up contribution of $6,500 to her 401k. Luckily, her work matches contributions one-for-one up to 6% of her salary – which means another $18,000 in her 401k, for a total of $44,000 that is pre-tax and will grow tax-deferred.

While she can also contribute $7,000 to a traditional IRA, her contributions will be nondeductible given her modified AGI level. The savings will still grow tax-deferred, so she 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 Contribution Growth Over Time

AGE YEARS WORKED NO GROWTH 8% GROWTH 22 0 $0 $0 23 1 $8,000.00 $8,000.00 24 2 $27,500.00 $29,700.00 25 3 $47,000.00 $53,136.00 30 8 $144,500.00 $201,624.83 35 13 $242,000.00 $419,803.64 40 18 $339,500.00 $740,379.90 45 23 $437,000.00 $1,211,411.59 50 28 $534,500.00 $1,903,511.67 55 33 $632,000.00 $2,920,433.76 60 38 $729,500.00 $4,414,625.94 65 43 $827,000.00 $6,610,084.46

Based on the above chart, you can see how 401k savings can really start adding up over time. The “no growth” end assumes a consistent maximum contribution at the 2021 limit of $19,500 after the first year contribution of $8,000 with zero company match and zero growth. The “8% growth” column assumes a consistent maximum contribution of $19,500 plus an 8% annual rate of return with zero company match. Generally, financial planners say the expected rate of return for a 401k is between 8% and 10%.

Suggested Next Steps for You

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.

1. Sign up for Personal Capital’s free financial tools.
2. Link your financial accounts, like your 401k and IRA, and run the Retirement Planner to project your chances for a successful retirement.
3. Consider talking to a fiduciary financial advisor about your retirement plan.