Can You Invest in Both an IRA and 401k at the Same Time?

Of the various defined contributions plans out there today, the two most popular are individual retirement accounts (IRAs) and 401k plans. Both have their advantages and disadvantages, and both are widespread; it’s estimated that 50 million Americans have a 401k plan and 47 million have an IRA of some kind.

While you can have more than one IRA at some point – and many do – many people wonder if you can invest in a 401k and an IRA at the same time, thereby taking advantage of the benefits of each and diversifying your investment.

Is that possible? Here, I’ll answer that question while providing you with key insights about 401ks and IRAs so you can make an informed choice about your next retirement savings plan.

Investing in IRAs and 401ks

For those wondering if you can invest in 401ks and IRAs at the same time, the short answer is simple: Yes, you can.

Whether you should, though, is another question altogether. Plus, it may make sense for you to pick one or the other, depending on your situation and financial requirements. But, you can have an IRA and a 401k, and the two do not really have much to do with one another (with one exception that we’ll talk about).

The main thing to know about a dual investment strategy is that the numbers related to each plan are not related to one another. Both plans have annual contribution limits, as you may already know.

The good news is that there is no one, single limit for all of your contribution plans. For example, for 2012, you are limited to $17,000 for your own contributions for your 401k plan; for your IRA accounts, you are limited to $5,000, or $6,000 if you are over the age of 50. Note that the IRA number is for all of your IRA accounts, whether you have a traditional IRA or a Roth IRA.

So, if you have two plans, you can contribute $22,000 if you are under the age of 50 or $23,000 if you are over the age of 50 (plus $5,500 a year for your 401k if you are 50 or over for catch-up contributions).

Should You Have Both?

I’m a big believer in maxing out your contributions if at all possible. You get a tax-deferred way to grow your money and enjoy the power of matched contributions from your employer with your 401k. In fact, that is one big advantage a 401k has over an IRA – an employer can match your 401k contributions and give you free money while you’re on your own with an IRA.

That doesn’t mean you should just go with a 401k, though. If you can also contribute to an IRA or an Roth IRA, do it – that just gives you yet another avenue to grow even more tax-deferred money.

Contributions to a traditional IRA may even be tax deductible, even if you contribute to a 401k plan too. Whether or not you can do that depends on your modified adjusted gross income (consult your accountant for specific details).

You can also benefit from a Roth IRA because withdrawals from a Roth IRA aren’t taxed hen you withdraw them. This is advantageous if you are going to be in a higher tax bracket when you begin your withdrawals than you are now (it’s the other way around for a traditional IRA).

The thing to keep in mind is that if you make in excess of $105,000 a year (single) or $173,000 (married), you won’t be able to make the full contribution to your IRA accounts. Your 401k plan generally will be unaffected by your income unless you fall into a category called “highly-compensated employee”. This is determined by your company and could lower your contributions.

Basically, if you can contribute comfortably to both plans, do so. A 401k gives you the advantage of matched employee contributions, while an IRA gives you flexibility and independence from your employer. It also gives you tax advantages, either by tax-deductible contributions (with a traditional IRA) or potential tax savings (with a Roth IRA).

Choosing One or the Other

If you can only invest in one, which one should you choose?

All other things being considered equal, go with a 401k, if only because you can grow your net worth through matched employer contributions (which really is free money). 401k plans have higher yearly contribution limits, too, which means you can save more for retirement – even if you might possibly pay more for retirement.

You usually don’t have to pick just one, though; go for both if you can and really maximize your savings and investments for retirement.

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