When you’re saving for retirement, one of the questions that will be sure to come up is: Can I contribute to both a 401k and IRA?
Both types of retirement plans are great ways to build up your nest egg through disciplined savings and compound growth. But they can also offer some unique tax benefits that make them a much better option over traditional methods of investing.
The good news is that for most middle-class Americans, the answer is “yes”, you can contribute to both a 401k and IRA. However, there are some specific IRS rules that you’ll need to follow. Here’s what you need to know.
Question 1 – What is Your Tax Filing Status?
The first question you’ll need to answer is which tax filing status you check when you prepare your federal income tax return each year. This is typically one of the following:
- Head of household
- Married filing jointly
- Married filing separately
- Qualifying widow(er)
Question 2 – Is Your Spouse Covered by a Workplace Retirement Plan?
The second question that the IRS needs to know is if you’re already participating in a retirement plan through your employer. Obviously, if you’re contributing to a 401k, then the answer is “yes”.
However, another person this could affect is your spouse. Depending on which people in the household are covered by workplace retirement plans will impact if they can use an IRA or not.
The same is also true the other way. If your spouse contributes to a 401k, 403b, or 457 plan, then it may have some impact on your ability to contribute to an IRA as well.
Question 3 – How Much Money Do You Make?
The third question for IRA eligibility is how much money you make. If your earnings exceed a certain amount, then this may also limit your ability to contribute to an IRA.
Your earnings are measured by the IRS using what’s called your AGI or adjusted gross income. Your AGI is a number that is calculated on your federal income tax return. It includes all of your income (or combined income if you file married) plus other sources of income (like interest and dividends) minus any other “above the line” adjustments (such as traditional IRA contributions).
For reference, AGI does not include itemized or standard deductions. These are considered “below the line” adjustments made after the AGI calculation.
Contributing to a Traditional IRA
If it’s a traditional IRA that you’d like to put your money into, then you’ll need to take your answers from Questions 1, 2, and 3 and see if you qualify. Here are the latest requirements from the IRS:
- 2021 IRA Deduction Limits if You Are Covered by a Retirement Plan at Work
- 2021 IRA Deduction Limits if You Are NOT Covered by a Retirement Plan at Work
- If your tax filing status is “single” or “head of household”, your AGI is $66,000 or less, and you also contribute to a 401k, then you can also contribute to a traditional IRA.
- If your tax status is “married filing jointly”, your AGI is $105,000 or less, and you contribute to a 401k plan, then you can also contribute to a traditional IRA.
- If your tax filing status is “married filing jointly”, your AGI is $198,000 or less, and your workplace does not offer a retirement plan but your spouse participates in one, then you can also contribute to a traditional IRA.
Using a Non-Deductible Traditional IRA Instead
Usually, when people talk about traditional IRAs, they’re thinking of “deductible” traditional IRAs. This is the arrangement where you can deduct IRA contributions from your AGI and defer paying taxes on them. However, if you don’t qualify for a deductible traditional IRA, then you may still be able to contribute to what’s called a “non-deducible” traditional IRA.
What’s a non-deductible traditional IRA? It’s basically a traditional IRA where you’re not allowed to take a tax deduction. So instead of subtracting this contribution from your income, it would be considered a part of your AGI calculation and therefore taxed.
Why would you want to do that? Because everything else about the traditional IRA is the same. Your savings will still be invested and grow tax-deferred until it’s time to retire. Though that may not sound like a huge advantage, it can be pretty substantial since we could be talking about decades of acquiring capital gains and dividends where you’ll avoid paying taxes.
Contributing to a Roth IRA
If it’s a Roth IRA that you’d to contribute to in addition to your 401k, then the requirements work a little differently than they did for a traditional IRA. For starters, the IRS doesn’t care if your employer offers a workplace retirement plan or not. So question 2 does not apply.
Instead, they will only be interested in your tax filing status and AGI (questions 1 and 3). Here are the latest requirements from the IRS:
One major caveat is that if you don’t meet the AGI requirements for contributing to a Roth IRA, then you can’t contribute to one at all. There is no “non-deductible” version of a Roth IRA since contributions are already non-deductible by design.
- If your tax filing is “single” or “head of household” and your AGI is less than $125,000, then you can contribute to a Roth IRA.
- If your tax filing is “married filing jointly” or “qualifying widow(er)” and your AGI is less than $198,000, then you can contribute to a Roth IRA.
- If your tax filing is “married filing separately” and you lived with your spouse at any time during the year, then you cannot contribute to a Roth IRA if your AGI was more than $10,000.
Roth IRA Conversions
If you exceed the IRS limits to contribute to a Roth IRA and would still like to do so, there’s good news: Taxpayers are allowed to convert traditional IRA contributions into Roth IRAs. This applies to both deductible and nondeductible IRA contributions.
Therefore, if you’re a high-income earner, the path you could take is to contribute to a non-deductible traditional IRA. Afterward, you could then convert those contributions into a Roth.
You’d still owe taxes on any gains you earned before the conversion was made, so you’d need to file Form 8606 with your federal tax return. To make sure you’re doing this correctly, you should work with a trusted tax professional.
If you’d like to see how contributing more money into your 401k and IRAs will make a difference to your retirement nest egg, then let an app like Buxfer help. Buxfer’s Plans feature lets you forecast your investments and net worth over time. Seeing how high this can go can be a great motivator to encourage you to save even more.
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