Can I Contribute To Both a 401k And an IRA?

Both 401(k) plans and IRAs are excellent ways to save for retirement. Unfortunately, although personal finance can be complicated, it's nothing compared to income taxes. When investing, finance, and retirement planning are combined with IRS rules and regulations, it isn't pretty. As a result, there are a lot questions and misunderstandings about how retirement saving accounts like traditional IRA, Roth IRA, and 401(k) accounts interact with each other.

One of the most commonly asked questions about 401(k)s and IRAs is whether or not a person can contribute to BOTH an IRA and a 401(k) at the same time.

401(k) Contributions

To contribute to a 401(k) plan at work, you must have an employered sponsored 401k retirement plan. Contributions to 401(k)s are typically made via payroll deductions which allows for the money invested in a 401(k) to be pre-tax funds.

The definition of pre-tax funds is any money earned, but not taxed.

The idea is basically that between when your employer pays you, and money gets withheld for income taxes, the money is diverted into your 401(k) account, before it ever gets taxed. Not only do you not get taxed on those dollars, they do not count as income either. It's the equivelent of earning less money for tax purposes. That makes it easier to qualify for tax-credits and tax deductions that have income limits or phase-outs.

The maximum contribution limits to a 401(k) is up to $17,500 per year unless certain special circumstances apply, like being an owner in the company, or being considered a highly-compensated employee.

IRA Contributions

IRA accounts, or Individual Retirement Accounts (Individual Retirement Arrangements, according to IRS Publication 590), are accounts opened an owned by an individual. IRAs have nothing to do with business, nor your employer. They are personal accounts. They are legally defined this way, which also means that there is no such thing as a joint IRA account.

There is one, and only one, way in which your employer sponsored retirement plan has any affect on your IRA contributions.

Contributions to a traditional IRA may be tax deductible. However, this tax deduction has an income limit. How much income you can earn and still make a tax deductible IRA contribution depends on whether or not your employer offers a qualified retirement plan. If so, then the income limits for tax-deductible IRA contributions are lower than if your employer does not offer a retirement plan.

Contribute To Both IRA and 401(k)

There are no other links between IRAs and 401(k)s. That means that you can contribute the maximum to both a 401k and a IRA in the same year. Of course, you can also contribute lesser amounts, but you can invest in both an IRA and a 401(k) in the same year regardless of the amounts, as long as you do not exceed the maximum 401(k) contribution limit or the IRA contribution limit.

The limit on contributions to IRA accounts is separate from the limit on contributions to 401(k) accounts. So, you can max out your 401(k) and still contribute something to an IRA, or you can max out your IRA and contribute to your 401(k).

There is one advanced tax planning strategy that comes into play with 401(k) accounts and IRA accounts.

Remember that the amount you can deduct on your taxes for an IRA contribution made into a traditional IRA depends upon the amount of your income. Also, remember that contributing to a 401(k) with pre-tax dollars lowers your gross income for IRS tax purposes.

Thus, for a higher-income tax payer close to the limitations on income for deductible IRA contributions, it will be advantageous to contribute the amount of money necessary to bring the income under the limits. By lowering your overall income level through pre-tax 401(k) contributions, you can make your IRA contributions tax deductible as well.

Can you contribute to both a traditional IRA and a Roth IRA?