Opening & Contributing to Both a 401(k) & an IRA

Can You Have Both a 401(k) And an IRA?

The quick answer is yes, a 401(k) and an IRA can both be utilized at the same time.

In fact, it is a common practice among many retirement investors.

Before understanding how to manage both a 401(k) and an IRA, it is helpful to understand the features of both plans.

What Is a 401(k)?

A 401(k) is a defined contribution plan with employer contributions.

These plans are pre-tax deductions from each paycheck that go into the specified account. The money grows tax free until withdrawal, when it will be taxed at ordinary income rates depending on what bracket you fall into.

A common benefit of a 401(k) plan is matching employer contributions. This is where the company will match a percentage of your salary contribution into your 401(k) account.

This matching contribution may come in the form of a dollar amount, a percentage of the employee's salary, or a percentage of the contribution made by the employee to the 401(k) account.

The drawback of a 401(k) is the large number of administrative and management fees that will be paid by the employer, which in turn will be deducted from your account.

What Is an IRA?

An IRA (Individual Retirement Account) is designed to encourage people to save for retirement. It is a savings account with tax advantages, and does not offer employer contributions.

Contributions to an IRA are tax deductible, and the money grows tax free until withdrawal. There is a ceiling for how much you can contribute into your IRA every year based on which type of IRA you have: a Roth IRA or a traditional IRA.

The advantage of an IRA is the vast number of investment options available compared to 401(k) plans. This offers an edge when diversifying your investments for your retirement.

The drawback of an IRA is the lower contributions that can be made into the account.

The maximum allowable contribution to an IRA in 2022 is only $6,000 for holders below 50 years old, and $7,000 for those who are 50 and above.

If you have multiple IRAs, the limit will apply across all the IRAs that you maintain.

Advantages of Having Both a 401(k) and an IRA

Here are some of the advantages when you maintain both a 401(k) and an IRA:

Opportunity to Increase Overall Contribution to Retirement Accounts

When you have both a 401(k) and an IRA, you can increase your overall contribution to your retirement accounts.

You may make additional contributions from each paycheck, maximizing the contribution limits of both plans individually.

By doing this, you will be able to save more for your retirement.

Tax-Deferred Growth of Contributions

Since a 401(k) and an IRA are both tax-deferred accounts, your money will grow tax free until withdrawal.

Tax-sheltered growth is an advantage of having both a 401(k) and an IRA as you can earn more on your investment due to the lack of taxation during the duration that the money is invested.

Disadvantages of Having Both a 401(k) and an IRA

Here are some of the disadvantages when you maintain both a 401(k) and an IRA:

Administrative Fees Paid by Employer for Management of Both Plans 

When you have both a 401(k) and an IRA, employers may face additional administrative fees for managing two different retirement accounts instead of one.

These extra fees are passed on to employees in the form of lower contribution limits or bigger deductions from your paycheck, reducing your take home pay.

Limited Tax Deduction for IRAs

Factors like income and whether or not you are covered by a retirement plan at work affect the tax-deductible limit for an IRA.

The lesser the contribution you make to your IRA, the lower your deduction will be. This can also result in more money being subject to taxation, which is one of the drawbacks of having both a 401(k) and an IRA.

Maximizing Both a 401(k) and an IRA

In order to maximize the benefits of both a 401(k) and an IRA, contributions should be made at least to the extent that all applicable contribution limits are satisfied.

For example, the IRA contribution limit in 2022 is $6,000 for people who are below 50 years old, and $7,000 for those who are 50 and above.

If you cannot make the maximum allowable contribution to both your 401(k) and IRA at once, you can start by maximizing your 401(k) first before making contributions to an IRA.

By doing this, you will be able to save more for your retirement.

Contribution limits to each type of account should be maximized to take advantage of tax deferral and tax-free growth.

It is also helpful to look into the investment options that you have for each plan and invest in a way that diversifies your investments.

Final Thoughts

In summary, there are both advantages and disadvantages when you maintain both a 401(k) and an IRA.

When done effectively, having both a 401(k) and an IRA can give you greater flexibility in saving for retirement while maximizing the benefits of each account.

Just make sure to carefully weigh between the advantages and disadvantages of having both a 401(k) and an IRA before moving forward.

Discussing these matters with a financial advisor can help you come up with the best decision.

FAQs

1. Can employers make contributions to your 401(k)?

Employers can contribute to your 401(k), as well as providing matching funds if they have a match program. Employers may also offer profit sharing contributions, depending on their plan terms.

2. What are some examples of qualified distributions from a 401(k)?

Qualified distributions from a 401(k) can include those that are made after you separate from service at age 55 or older, become disabled, or are used for your first home purchase. You may also take out a loan from the plan, but this has different rules depending on your plan’s terms.

3. Can you invest directly in an index fund through your employer's retirement plan?

Yes, you can invest directly in an index fund if your employer offers this option through its retirement plan. This opens up more investment options at lower fees than mutual funds or actively managed funds, so this may be one way to contribute to both a 401(k) and an IRA .

4. Where can I open my IRA?

There are many different places that offer IRA accounts, but it is best to choose somewhere that has low fees and provides good investment options so that you can maximize its benefits.

5. How do I know what investment options my employer offers in its retirement plan?

Your employer's retirement plan provider or administrator should be able to provide all of the relevant information regarding the different investment options available, as well as their fees and expenses.