When it comes to building retirement savings, it’s easy to feel confused about where you can save, and how much. One of the most frequent questions we encounter is, “Can I contribute to both a 401(k) and IRA?”

The answer is yes. In fact, this is the most ideal situation for individuals as it allows you to take advantage of the various tax benefits of both retirement accounts. However, while you can always contribute to both accounts, your eligibility to receive the tax benefits of these plans depends on your income. If you (and your spouse, if filing jointly) exceed income limits by the IRS, you may not be able to take full advantage of the tax benefits of both.

To better understand this, it’s important to first examine how each investment vehicle works. For a quick refresher, we outlined the basics below.

What Is a 401(k)?

In simple terms, a 401(k) plan is a retirement savings account offered by your employer, with contributions set as a consistent monthly amount, typically as a percentage of your salary.

The main advantage of a traditional 401(k) is that you can make contributions straight from your paycheck pre-tax—saving you 10% to 37% on your contributions, depending on your income tax rate.

Investment growth in your 401(k) is also tax-deferred meaning you don’t need to pay annual taxes on interest earned. All of this adds up to a big upside for long-term, tax-deferred growth. However, with a traditional 401(k) you will need to pay income tax on all your earnings when you withdraw from the account.

Another benefit of a 401(k) is that many employers will match up to a certain contribution amount, effectively doubling your savings. Every company differs in their contribution matching limit, but a common amount is a 50 cents match for every dollar, up to 6% of an employee’s pay. (More on how to track your company’s 401(k) matching here.)

However, with all the benefits come a few restrictions. The most significant is the contribution limit of $19,500 for employees in 2020. There is also a 10% early distribution penalty tax if you access your funds before age 59½, but the CARES Act may let you waive that penalty if you made an early withdrawal for reasons related to the pandemic, including financial hardship.

What Is An IRA?

An IRA (or Individual Retirement Account) is an individual retirement savings plan. The difference between a 401(k) and IRA is that IRA contributions are not pre-tax. However, growth in your IRA is still tax-deferred, meaning you don’t have to pay yearly taxes on gains made through investment. The contribution limit for IRA is $6,000 a year.

When it comes to IRAs, you’ll often hear the terms “Roth” and “Traditional.” The difference breaks down to when you pay taxes.

In a traditional IRA, you are able to deduct the amount you contribute from your taxable income—lowering how much you pay annually in taxes—but on the flip side, you have to pay taxes when you withdraw your funds in retirement.

For example, if you contribute the maximum of $6,000 to your IRA, and earn a salary of $50,000, your taxable income is now $44,000 (because you deducted the $6,000 contribution amount).

On the other hand, with a Roth IRA, you don’t get any tax deductions while you contribute, but you can withdraw all your money tax-free in retirement. The decision to choose one plan over the other is personal, and largely depends on how much money you need now, and what your projected income will be at the time of your withdrawal.

Limitations on Having Both an IRA and 401(k)

As mentioned, while you are always eligible to contribute to both retirement accounts, if your income is too high, you may not be eligible for the tax benefits of both. To work through this yourself you need to answer two questions:

  1. Do you participate in a work-sponsored retirement plan (e.b, 401(k))? If you are filing jointly, does your partner participate in their employer’s plan?
  2. What is your adjustable gross income? This determines how much you pay in taxes.

If you answered “no” to the first question, then you’re set. However, if you or your partner participate in a work-sponsored retirement plan such as a 401(k), you will be ineligible to deduct your IRA contributions because your income exceeds what’s known as the “phase-out limit.”

If you are filing as single or head of household, the phase-out limit is between $64,000 and $74,000. If your income is less than $64,000, you are eligible for full tax deduction of your contribution to an IRA. If it’s over $74,000, you are not eligible, and if you are in between you are eligible for a partial deduction.

If you are filing jointly, the limit is $103,000 to $123,000. The same rules apply (under $103,000 you get full deduction, over $123,000 you get no deduction, and a partial deduction in the middle).

For this reason, it’s very common for high earners to bundle a traditional 401(k) with a Roth IRA. This is because there is already no deduction on Roth IRAs, so there is no tax benefit loss if you exceed the phase-out limit. Generally speaking, individuals will always want to max their 401(k) first, as company matching gives you an unparalleled opportunity to increase your retirement funds.

401(k) and IRA Planning That Works for You

You can always contribute to both an IRA and 401(k). However, if your income exceeds the phase-out limit ($74,000 for individuals and $123,000 for joint filers), then you will likely want to couple a traditional 401(k) with a Roth IRA, in order to maximize the tax benefits of each respective account.

To learn more about retirement contributions, 401(k)s, or IRAs, we recommend checking out our retirement planning center.