THE QUICK AND DIRTY
When your income exceeds annual thresholds for your tax filing status, you might get fewer or no tax benefits for having a retirement plan at work and a traditional IRA. Find out the income limits and how to choose the best retirement accounts for your situation.
A podcast listener named Justin says, “I maxed out my 401(k) for 2022 and still have more money to invest. Can I also max out an IRA—and if so, would the contribution also be tax-deductible?”
Justin, thanks for your question, and congratulations on being such a good saver! I’ll answer your question in this post by reviewing the retirement account contribution rules and pitfalls to avoid.
Can you contribute to a 401k and an IRA in the same year?
The short answer to the question is yes; you can contribute to a workplace retirement plan and an IRA (Individual Retirement Account) in the same year. However, having an extra retirement account changes the tax rules and benefits you receive in some cases. So, keep reading to learn how to take advantage of multiple retirement accounts in the same year.
First, let’s touch on why you’d want more than one retirement account. The primary benefits are saving more for retirement and reducing your current or future tax liability. Those are extremely powerful and why I’m a huge fan of tax-advantaged accounts. So, having more than one retirement account can help you build more wealth.
How much can you contribute to retirement accounts?
For 2022, workplace retirement plans, such as a 401(k) or 403(b), allow you to contribute up to $20,500 or $27,000 if you’re over age 50. If you’re like Justin and max one out with cash to spare, saving more in an IRA is a smart move.
For 2022, the IRA contribution limits are much lower than workplace plans at up to $6,000 or $7,000 if you’re over 50. All the limitations I’ve covered apply whether you use a traditional or Roth IRA or account at work.
READ MORE:
IRA Contribution Rules When You Have No Income
What are the differences between traditional and Roth retirement accounts?
Here’s a primer on the differences between traditional and Roth retirement accounts. With any traditional account (such as a traditional 401(k) or traditional IRA), you make pre-tax contributions, giving you a nice tax deduction in the year you make them. You skip paying income tax on the funds you invest and their 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, on the untaxed portion. 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 Roth IRA), you can only make after-tax contributions, which don’t offer any tax benefit in the current year. However, the terrific upside of a Roth is that withdrawals of both contributions and investment earnings are tax-free in retirement if you’ve had the account for at least five years.
You may have significant account growth in a Roth, and it never gets taxed, which could give you massive savings. You can even withdraw your original contributions before retirement without owing taxes or a 10% early withdrawal penalty. That gives you flexibility not offered by any other type of retirement plan.
So, the main difference between a traditional and Roth account is how and when you pay taxes. A traditional retirement account helps cut your current income tax bill on contributions. And a Roth allows you to avoid future income tax on contributions and earnings.
READ MORE:
Should I Get a Traditional or Roth IRA?
Having a traditional IRA and a retirement plan at work
Now that you understand the retirement account contribution limits and the main differences between traditional and Roth accounts, let’s cover the downside of contributing to a workplace and individual retirement account in the same year.
Suppose you or a spouse participate in a retirement plan at work. In that case, your tax deduction for traditional IRA contributions may be reduced or eliminated, depending on your modified adjusted gross income (MAGI) as follows for 2022:
- Single taxpayers get a full deduction when your MAGI is up to $68,000 and a partial deduction up to $78,000. You receive no deduction at or above $78,000.
- Married taxpayers filing a joint return get a full deduction when your household MAGI is up to $109,000 and a partial deduction up to $129,00. You receive no deduction at or above $129,000.
- Married taxpayers filing separate returns get a partial deduction when your MAGI is less than $10,000 and no deduction at or above $10,000.
So, if Justin is single with an income that’s less than $68,000, he could get a full deduction for his traditional IRA contributions. But if he earns more than $78,000, he’s out of luck. And if Justin is a married guy who files taxes with a spouse, he’s unable to claim a deduction if their household income tops $129,000.
If Justin is single with an income that’s less than $68,000, he could get a full deduction for his traditional IRA contributions. But if he earns more than $78,000, he’s out of luck.
In other words, if your income is below these thresholds for your tax filing status and you want an additional tax deduction for the year, then contributing to both a traditional workplace plan and a traditional IRA is a great option.
Here’s another situation that affects married people. Let’s say that Justin’s spouse works for a small company that doesn’t offer a retirement plan. Because Justin is covered by a 401(k), that limits how much the spouse can deduct for a traditional IRA based on their household income.
If you’re not covered by a retirement plan at work, but your spouse is, here are the rules for 2022:
- Married taxpayers filing joint returns get a full deduction when household MAGI is up to $204,000 and a partial deduction up to $214,000. You receive no deduction at or above $214,000.
- Married taxpayers filing separate returns get a partial deduction when your MAGI is less than $10,000 and no deduction at or above $10,000.
What are deductible and non-deductible retirement account contributions?
If you have a workplace retirement plan and your income is above the threshold to qualify for a full deduction with a traditional IRA, you may be wondering if you should still use one. What’s the point of contributing to a traditional IRA if it doesn’t come with a full tax deduction?
Well, non-deductible contributions to a traditional IRA still allow you to defer tax on their investment growth–until you make withdrawals in retirement. That’s an excellent benefit!
But a downside to having a traditional IRA that contains deductible and non-deductible contributions is that the recordkeeping gets tricky. If you or your custodian don’t keep it straight, you could pay tax twice on the same funds in retirement. So, I recommend keeping them separate by opening an additional traditional IRA for your non-deductible contributions. That prevents confusion about which funds have already been taxed and which haven’t.
IMPORTANT!
To help with the recordkeeping, you must file IRS Form 8606, Nondeductible IRAsopens PDF file , when you make non-deductible contributions to a traditional IRA.
Who qualifies for a Roth IRA?
If your income is too high to qualify for deductible traditional IRA contributions when participating in a workplace retirement plan, consider using a Roth IRA instead. Because Roth contributions are not deductible (you must pay them on an after-tax basis), there’s never a conflict with having one in addition to a workplace account.
If your income is too high to qualify for deductible traditional IRA contributions when participating in a workplace retirement plan, consider using a Roth IRA instead.
However, there’s a catch to having a Roth IRA for high earners. If you earn over an annual threshold, you’re not allowed to make Roth IRA contributions that year. Here are the Roth IRA income limits for 2022:
- Single taxpayers can’t contribute when their MAGI is at or above $144,000.
- Married taxpayers filing a joint return can’t contribute when their household MAGI is $214,000 or higher.
- Married taxpayers filing separate returns can’t contribute when MAGI is $10,000 or higher.
So, getting back to Justin’s question about whether maxing out a traditional IRA would be tax-deductible. The answer depends on his tax filing status and income.
Justin, if you’re single and earning about $68,000 or less, you can have a 401(k) and get a full tax deduction from traditional IRA contributions. Or, if you file a joint return and earn about $109,000 or less, you get the full tax benefit of both accounts.
If you earn over those amounts but less than the Roth IRA income limits, I highly recommend using a Roth IRA in addition to a workplace retirement plan. Again, the thresholds are $144,000 for singles and $214,000 for joint taxpayers. While a Roth IRA doesn’t give you an upfront tax benefit, it may provide you with something even better, tax-free income in retirement.
When you participate in a workplace retirement account and your income is too high to qualify for deductible traditional IRA contributions or a Roth IRA, your only option is to make non-deductible traditional IRA contributions. While you won’t get an immediate tax benefit for them, your investment gains are tax-deferred until you make withdrawals in retirement, which is still a terrific benefit not to overlook.
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