When saving for retirement, workers should consider contributing to a 401(k) plan and an individual retirement account at the same time. Both types of retirement accounts allow you to defer paying income tax on your retirement savings, and contributing to a 401(k) and IRA could significantly reduce your tax bill. However, high earners may not be able to claim a tax deduction on contributions to both types of accounts in the same year.
If you’re thinking of saving in a 401(k) and IRA, consider the following:
— Contribution limits for 401(k)s and IRAs.
— Income limits for traditional IRA contributions.
— Saving in a 401(k) and a Roth IRA.
— How to decide where to save.
Contribution Limits for 401(k)s and IRAs
Employees are eligible to defer income tax on up to $23,000 that they contribute to a 401(k) plan in 2024. Those age 50 and older can make additional catch-up contributions of up to $7,000 for a total 401(k) contribution of $30,000. An employer may make additional contributions to the 401(k) plan on behalf of its employees or provide matching funds.
IRAs have a much smaller contribution limit of $7,000, plus an additional $1,000 catch-up contribution for workers age 50 and older.
“These contributions are independent of each other, so you can contribute to the maximum allowed,” said Stacey Chin, certified financial planner and private wealth advisor at Treehouse Wealth Advisors in Walnut Creek, California, in an email. To do so, you’ll need to meet certain eligibility requirements. Contributing to both types of accounts in the same year can allow you to defer income tax on as much as $30,000 if you are 49 or younger and $38,000 at age 50 or older.
The tax benefits of maxing out both a 401(k) and IRA can be significant. A worker who pays a 22% tax rate and can contribute $33,000 to a traditional 401(k) and IRA will reduce their current tax bill by $7,260. Income tax won’t be due on that money until it is withdrawn from the account.
[Related:What Is the Average Retirement Savings Balance by Age?]
Income Limits for Traditional IRA Contributions
Workers without access to a 401(k) account can make tax-deductible contributions to a traditional IRA regardless of how much they earn. Those who have a 401(k) at work can additionally save for retirement in a tax-deductible IRA unless their income exceeds certain limits.
Employees with a 401(k) account can’t claim a tax deduction for a 2024 IRA contribution if their income exceeds $87,000 as an individual and $143,000 as a married couple filing jointly. The IRA tax deduction is phased out for individuals earning more than $77,000 and couples earning more than $123,000. If only one member of a married couple has a 401(k) plan, the tax deduction is phased out when the couple’s income is between $230,000 and $240,000.
“If you have access to a 401(k), having an IRA gets tricky for people or families with high incomes,” said Haley O’Steen, assistant professor of finance at Pepperdine University in Malibu, California, in an email. “The higher your income, the less deductible IRA contributions you can make. This doesn’t mean you can’t make contributions, but those contributions are taxed immediately, as with a Roth IRA.”
[Read: How to Take Advantage of 401(k) Catch-Up Contributions.]
Saving in a 401(k) and a Roth IRA
You can also save for retirement in a 401(k) and Roth IRA in the same year. An after-tax Roth IRA has higher income limits than a traditional IRA. Those who earn less than $146,000 as an individual and $230,000 as a married couple can make Roth IRA contributions in 2024. The contribution amount is phased out for those earning more than $146,000 as an individual and $240,000 as a married couple. The Roth IRA income limits apply regardless of whether you have a 401(k) at work, but there are some ways around them, such as using a backdoor Roth or mega backdoor Roth strategy.
Contributing to a Roth IRA won’t get you a tax break in the year you make the contribution, but you will be able to take tax-free withdrawals in retirement. Saving in a traditional 401(k) and a Roth IRA adds tax diversification to your portfolio. When you have a traditional and Roth retirement account, you get to decide how much to withdraw from a taxable account and tax-free account each year in retirement, which can help you manage your tax bill.
[READ: 10 Reasons to Save for Retirement in a Roth IRA]
How to Decide Where to Save
If you can’t max out both types of retirement accounts, you may have to prioritize. “If your employer offers a match on 401(k) contributions, try to contribute at least enough to get the full match,” Chin said. “This is essentially free money and can significantly increase your retirement savings.”
After that, compare your 401(k) plan to an IRA to see which has better investment options and lower fees. “Often a 401(k) has more limited investment options than an IRA,” Chin said. “For more transparency and control, an IRA may be a better place to save. After leaving a job, rolling a 401(k) into an IRA may make more sense for many individuals.”
You can also evaluate your current income and what you’ll have coming in during retirement. “The amount of taxes you pay now and later in retirement is important when deciding how to save,” said Steven Kibbel, a certified financial planner at Kibbel Financial Planning in Franklin, Tennessee, in an email. “With pretax savings, the money goes in without paying taxes upfront. Upon retirement, withdrawals are taxed but usually at a lower rate than while working.”
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How to Save in a 401(k) and IRA in the Same Year originally appeared on usnews.com
Update 04/29/24: This story was previously published at an earlier date and has been updated with new information.
