Money Girl

6 Rules for Contributing to an IRA and a 401(k)

Episode Summary

Laura reviews six rules you should know to take advantage of multiple retirement accounts and avoid pitfalls.

Episode Notes

Laura reviews six rules you should know to take advantage of multiple retirement accounts and avoid pitfalls.

Money Girl is hosted by Laura Adams. A transcript is available at Simplecast.

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Episode Transcription

If you participate in a workplace retirement plan, like a 401(k) or 403(b), you may wonder how to get even more terrific tax-advantaged benefits. One way is to also contribute to an individual retirement account or IRA.

While you can contribute to a workplace plan and an IRA in the same year, having an extra retirement account can change the tax benefits you receive. This post will review six rules to take advantage of multiple retirement accounts and avoid pitfalls.

Hi, friends, and thanks for joining me this week! I'm Laura Adams, an author, media spokesperson, and money speaker hosting the Money Girl podcast since 2008, with over 42 million downloads.

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6 Rules for Contributing to an IRA and a 401(k)

The primary benefit of having multiple retirement accounts is that you can save more for retirement and cut more of your current or future tax liability. What's not to love about that?

Understanding the following six rules helps you optimize your retirement saving strategy.

1. Your workplace retirement contribution limit.

For 2024, employees who participate in 401(k), 403(b), most 457 plans, and the federal government's Thrift Saving Plan (TSP) can contribute up to $23,000 or $30,500 if you're over 50. That's $500 higher than 2023.

If you max out a plan at work or contribute enough to maximize employer matching funds and have cash to spare, contributing to an IRA is a smart money move.

LISTEN ALSO: 7 pros and cons of investing in a 401(k) at work

2. Your IRA contribution limit.

For 2024, the IRA contribution limit is also $500 higher than 2023. You can contribute up to $7,000 or $8,000 if you're over 50, with at least that much earned income. The limit applies to a traditional or Roth IRA, but not both.

For instance, you could put $3,000 in a traditional IRA and $4,000 in a Roth IRA if you're under 50 with qualifying income. I'll explain more about who qualifies for a Roth IRA next.

With a traditional account, such as a traditional 401(k) or IRA, you make pre-tax contributions, giving you a nice tax deduction the year you make them. You skip paying income tax on the money you put in the account and any investment earnings until you make withdrawals in retirement.

However, if you tap a traditional account before age 59.5, you must pay a 10% penalty, plus income tax. Therefore, you should only put money into a traditional retirement account that you won't need to spend until retirement.

When you use a Roth account, such as a Roth 401(k) or IRA, you make after-tax contributions, which don't offer any benefit in the current year. However, the terrific upside is having tax-free withdrawals of contributions and earnings in retirement, if you've owned the account for at least five years.

So, the main difference between a traditional and a Roth account is how and when you pay taxes. A traditional retirement account helps cut your current income taxes on contributions, and a Roth account allows you to avoid future income taxes on contributions and earnings.

3. Your Roth IRA eligibility.

While a Roth IRA sounds fantastic, there's a catch. You cannot make Roth IRA contributions when you earn over an annual threshold. Here are the Roth IRA income limits for 2024:

Single taxpayers with modified adjusted gross income (MAGI) at or above $161,000 are ineligible.
Married taxpayers filing a joint return with household MAGI at or above $240,000 are ineligible.
Married taxpayers filing separate returns with MAGI at or above $10,000 are ineligible.

So, if you earn less than those amounts, I recommend using a Roth IRA in combination with a workplace retirement plan. You may have significant account growth in a Roth, and as I mentioned, it grows tax-free, which could give you massive savings.

You can even withdraw your original contributions from a Roth IRA before retirement without owing taxes or a 10% early withdrawal penalty, giving you flexibility. Plus, because Roth contributions are nondeductible, there's never a conflict with having one in addition to a workplace account.

4. Your traditional IRA deductibility with a workplace plan.

Now that you understand various retirement account contribution limits and the main differences between traditional and Roth accounts let's cover the downside of contributing to a workplace plan and a traditional IRA in the same year. Your tax deduction for traditional IRA contributions may be reduced or eliminated depending on your income as follows for 2024:

If you're a single taxpayer covered by a workplace retirement plan, you get a reduced traditional IRA deduction with MAGI between $77,000 and $87,000 and no deduction at or above $87,000.
If you're married and file a joint tax return, you get a reduced deduction with household MAGI between $123,000 and $143,000 and no deduction at or above $143,000.
If you're married and file separate tax returns, you get a partial deduction when your MAGI is less than $10,000 and no deduction at or above $10,000.

Note that regardless of income, you can max out a workplace retirement plan and a traditional IRA any year. But you won’t be able to claim a tax deduction for your traditional IRA contributions if your income is within the limits I just reviewed.

5. Your traditional IRA deductibility with a spouse's workplace plan.

Here's another downside of contributing to a workplace retirement plan and a traditional IRA that affects married people. Let's say you work for a small company that doesn't offer a retirement plan, but your spouse does have one. That also limits how much you can deduct for your traditional IRA contributions.

If you're not covered by a retirement plan at work, but your spouse is, here are the rules for 2024:

If you're married and file a joint tax return, you get a reduced traditional IRA deduction with household MAGI between $230,000 and $240,000 and no deduction at or above $240,000.
If you're married and file separate tax returns, you get a partial traditional IRA deduction when your MAGI is less than $10,000 and no deduction at or above $10,000.

Remember that if neither you nor a spouse have a retirement plan at work, none of these limits apply, and you can claim a full tax deduction for traditional IRA contributions.