Top 5 Things You Need to Know About Contributing to an IRA and 401(k)

By Cynthia Turoski, on October 2nd, 2023

There is a lot to consider when it comes to personal finance. With so much information out there, it can often get confusing, especially in the area of retirement accounts.

Check out the below for the top five things to know about contributing to an IRA and a 401(k). Learn the ins and outs of contributing to both retirement plans, discover the tax implications of doing so, and find out how to maximize your retirement savings today.

1. You Can Contribute to Both an IRA and 401(k) in the Same Year.

You can contribute to both an IRA and a 401(k) plan in the same year. You can even contribute to a Roth IRA and a Roth account in your 401(k) plan in the same year if your company’s 401(k) plan has the Roth account feature. An IRA and 401(k) are separate plans with separate limits.

Some confuse being eligible to make an IRA contribution with whether it is deductible, thinking you can only make an IRA contribution if it is deductible. Depending on your income, you may not be able to make a deductible IRA contribution if you participate in a 401(k) plan. However, you can make an IRA contribution whether it is deductible or not.

2. Contribution Limits are Dependent on Age.

IRA

For 2023 IRA contributions, you can contribute the lesser of 1) $6,500 or $7,500 if you are age 50 and older, or 2) your earned income. This limit applies to all your IRAs combined. That means if you have a traditional IRA and a Roth IRA, you can only contribute up to those amounts in total across both IRAs.

401(k) Plan

For 2023, you can contribute to the 401(k) plan (pre-tax and/or Roth 401(k) accounts) up to $22,500 of your salary or $30,000 with the catch-up contribution if you are age 50 or older.

Note this contribution limit is an individual-level limit. Therefore, that is the total you can contribute across all 401(k), 403(b), SIMPLE 401(k) plans, and SAR-SEPs you may participate in, including through other employers.

You can see that you can get more into a Roth 401(k) account than you can into a Roth IRA, but keep in mind that you can’t access your Roth 401(k) balance whenever you want like you can with a Roth IRA*. Under most plans, you must be separated from service.

If your 401(k) plan allows after-tax contributions in addition to pre-tax or Roth 401(k) account contributions, you may be able to contribute even more to the plan. Since those contributions would be after-tax, you could do an in-plan Roth conversion (if the plan allows) to convert the after-tax balance to the Roth account where the earnings also grow tax-free. This is often referred to as a mega Roth.

*Though you can freely access your Roth IRA balance, withdrawals that aren’t qualified withdrawals may be subject to penalties and/or income tax.

When thinking of how much to contribute to the 401(k) plan, remember that your net paycheck isn’t reduced dollar-for-dollar by the amount of your contribution (the pre-tax portion). Some of that contribution is offset by reduced federal and state income tax withholdings due to the income tax savings on pre-tax contributions.

3. Contributions to One Plan Do Not Impact Allowable Contributions to the Other

You can contribute to your company 401(k) plan with no impact on what you can contribute to your IRAs and vice versa. An IRA contribution (traditional and/or Roth IRA) doesn’t reduce how much you can contribute to a 401(k) plan.

4. Tax Savings Depend on What Plan or Account You Contribute To.

A contribution to a Roth IRA is made with what is called “after-tax dollars,” meaning there is no tax deduction on contributions to a Roth IRA. There is no tax benefit on the front end. The tax benefit is on the back end. The account can grow tax-deferred like a traditional IRA, but even better than a traditional IRA – qualified distributions from a Roth IRA are tax-free in retirement. All the earnings can escape taxation. Note that you can always take out the amount you’ve contributed (not the earnings) tax-free and penalty-free whenever you want, but hopefully you leave it in there until retirement. The after-tax contribution creates tax basis, which is what makes it tax-free when taken out.

On the other hand, contributions to a 401(k) plan save you taxes when the contribution is made to a pre-tax account in the plan. It reduces the taxable wages that get reported on your Form W-2. If your company 401(k) plan has a Roth account feature, your contributions to that account won’t save you tax on the front end, similar to a Roth IRA.

5. Contributing to Both an IRA and a 401(k) Can Maximize Retirement Savings.

By contributing to both an IRA and a 401(k) plan, you maximize money growing tax-deferred for retirement savings. If some of those contributions are to a Roth IRA or 401(k) Roth Account, you diversify the tax treatment of your retirement savings. Pre-tax 401(k) plan distributions will be taxable when you take them whereas the Roth IRA or Roth Account withdrawals can be tax free. That gives you options. Also, 401(k) plans have required minimum distributions (RMDs) when you reach a certain age, but Roth IRAs do not.

We usually advise clients to delay taking distributions from their Roth IRA in retirement as long as possible since it can grow tax-free. Let it compound since there’s no RMDs. Possibly you won’t even need the money in your lifetime, and it can be a valuable tax-free asset you pass on to your heirs. Turn to other assets first, such as non-retirement accounts and your 401(k) plan when money is needed. That also gives the Roth IRA a longer time horizon. Perhaps it could be invested more aggressively then, further helping it grow and compound tax-free.

These retirement plan contributions add up over time to help support your lifestyle in retirement and give you more options. People often underestimate how much they need to save for retirement, especially if they don’t have a pension (most don’t). How much is enough is different for everyone depending on your lifestyle. Some people need more, others less. A high lifestyle requires more savings.

If you need further guidance or have any questions on this topic, we are here to help. Please do not hesitate to reach out to discuss your specific situation.

This material has been prepared for general, informational purposes only and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. Should you require any such advice, please contact us directly. The information contained herein does not create, and your review or use of the information does not constitute, an accountant-client relationship.

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Jess LeDonne
Director, Policy and Legislative Affairs
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Jess LeDonne
Director, Policy and Legislative Affairs