Can you have a 401k and an IRA?

A common question that frequently comes up when it comes to retirement planning is whether retirement savers can have both 401(k) and IRA. Find out the true position.

3 min read

If your employer offers a 401(k) plan, you should take advantage of the plan to grow your retirement savings. A 401(k) plan gives you an immediate tax break on your contributions, and you can reduce your taxable income in the year when you contribute to the account. You may also consider contributing to an IRA in addition to the 401(k) account you have with your employer.

You can have both 401(k) and IRA at the same time, and it is common for most retirement savers to have both retirement accounts. Both 401(k) and traditional IRA allow retirement savers to make tax-deferred savings and only pay taxes when they withdraw money in retirement. However, with a Roth IRA, you will pay taxes on contributions, but you won’t pay further taxes when you take a distribution in retirement.

Pros and Cons of 401(k)

Most employers offer 401(k) plans to their employees, and new employees may be eligible to join the 401(k) plan immediately. However, part-time workers may be required to complete 1000 hours in 12 months to participate in the company plan.

A 401(k) has higher contribution limits than an IRA, and you can contribute up to $20,500 in 2022 against an IRA’s $6000 annual contribution limit. By having both 401(k) and IRA, you can increase your annual contributions to $26,500.

If your employer offers a 401(k) match, you may get either a full or partial match on the contributions you make. You should contribute at least enough to collect the full employer match to increase your retirement contributions.

A 401(k) also offers protection from creditors if you are unable to pay a loan. If you lose your job and you are unable to pay back the loan, the lender cannot tap into your 401(k) to settle the outstanding loan balance.

On the downside, a 401(k) plan has limited investment options. Plan participants can only invest in a small pool of investment options handpicked by the 401(k) plan administrator. You can only invest in basic investments like stocks, bonds, and mutual funds.

Pros and Cons of IRA

One of the attractive features of an IRA is the wide pool of investment options. Unlike an IRA that has a limited choice of investment options, IRA investors can choose from a wide selection of investment options that include stocks, bonds, ETFs, real estate, tax deeds, among other options.

An IRA also allows retirement savers to get a tax deduction on their contribution, which helps lower the taxable income for the year. However, this benefit begins to phase out or is eliminated if your MAGI exceeds a certain limit.

Where one spouse is working and the other spouse has no income, the working spouse can contribute to a spousal IRA for their non-working spouse. This allows the married couple to increase their retirement savings.

On the downside, an IRA has a lower contribution limit than a 401(k). However, you can use an IRA to accelerate your retirement savings if you have maxed out your workplace retirement plan. For 2022, you can contribute up to $6000 to a traditional or Roth IRA, or $7000 if you are above age 50.

Choosing between a 401(k) and IRA

If you have a 401(k), you may also consider opening an IRA. However, before you decide to have both retirement accounts, there are certain considerations you should make.

If your employer offers a 401(k) match, you should contribute enough to collect the entire match. The match does not count towards the annual contribution limit. For 2022, the combined employee and employer contributions can go up to $61,000, or $67,500 for older employees above 50.

Once you get the full match from your employer, you can then decide to open and contribute to an IRA. With an IRA, you can get a tax deduction on your contributions, a wider pool of investments, and an opportunity to lower your 401(k) fees.

You might also consider opening a Roth IRA instead of a traditional IRA to enjoy tax-free distributions in retirement. You will pay taxes upfront when you contribute to the account. You can also decide to rollover old 401(k)s to the Roth IRA, but you will pay taxes on the retirement savings since a Roth IRA is funded with after-tax dollars.

What if you contribute too much?

If you contribute to a 401(k) and an IRA without tracking the contributions, you may discover that you contributed too much in a specific year. Once you discover the over-contribution, you should act immediately to avoid paying a tax on the excess amount.

Usually, any excess amount contributed to your 401(k) or IRA is liable to a 6% penalty every year the amount remains in the account. However, this penalty can be waived if you withdraw the excess contribution before the tax due date for the year in which the contributions were made.

You must also determine the gains earned from your excess contribution and remove this amount as well. You will still include the investment earnings in your gross income for the year, in addition to a 10% penalty if you are below age 59 ½.