Is It Good to Have an IRA and a 401k?

Retirement planning often involves using various strategies to build a secure financial future. Individual Retirement Arrangements (IRAs) and 401(k) plans are two widely used tools for long-term savings. Understanding their distinct characteristics and how they complement each other is key to optimizing personal retirement contributions. Many individuals consider using both account types to enhance their savings potential.

Individual Retirement Accounts and 401(k) Plans

Individual Retirement Arrangements (IRAs) are personal retirement savings accounts opened independently through a financial institution. These accounts are not tied to an employer, offering flexibility in management and investment choices. Traditional and Roth IRAs are the two most common types, each offering different tax benefits. A Traditional IRA generally allows for pre-tax, tax-deductible contributions, with earnings growing tax-deferred until retirement. Conversely, a Roth IRA involves after-tax contributions, and qualified withdrawals in retirement, including earnings, are entirely tax-free. Both require earned income to contribute. For 2025, the maximum IRA contribution is $7,000, with an additional $1,000 catch-up for those aged 50 or older, totaling $8,000.

In contrast, a 401(k) plan is an employer-sponsored retirement savings program. Employers establish these plans, with contributions typically made through payroll deductions. Like IRAs, 401(k)s come in Traditional and Roth versions, offering pre-tax or after-tax contribution options. Many 401(k) plans feature employer matching contributions, where the employer contributes based on employee contributions. For 2025, employees can contribute up to $23,500 to their 401(k), with an additional $7,500 catch-up for those aged 50 or older. A higher $11,250 catch-up contribution is available for individuals aged 60 to 63, if the plan allows.

Key Differences Between IRAs and 401(k)s

Contribution Limits

Annual contribution limits are a primary distinction. For 2025, individuals under age 50 can contribute $7,000 to an IRA, while the 401(k) limit is $23,500. These higher 401(k) limits allow for greater annual savings accumulation, especially with catch-up contributions. Total combined employee and employer contributions to a 401(k) can reach $70,000 in 2025, highlighting their significant savings capacity.

Employer Contributions

Employer contributions are exclusive to employer-sponsored plans like 401(k)s. Many employers offer matching contributions, significantly boosting an employee’s retirement savings without additional personal outlay. This match is a form of compensation, making it prudent to prioritize 401(k) contributions up to the maximum offered. IRAs, as individual accounts, do not receive employer contributions.

Investment Options

Investment options typically vary. IRAs generally offer a broader range of choices, including individual stocks, bonds, mutual funds, and exchange-traded funds, providing extensive control over the portfolio. In contrast, 401(k) plans usually have a more limited selection of options, curated by the plan administrator. While this simplifies decisions, it may restrict access to certain asset classes or specific investment vehicles.

Tax Treatment

Regarding tax treatment, both IRAs and 401(k)s offer Traditional (pre-tax) and Roth (after-tax) options, but their implications differ. Traditional accounts allow for tax-deductible contributions and tax-deferred growth, with withdrawals taxed as ordinary income in retirement. For Traditional IRAs, contribution deductibility can be limited based on income and workplace plan coverage. Roth accounts feature after-tax contributions, tax-free growth, and tax-free withdrawals in retirement, provided conditions are met. Roth 401(k)s have no income limits for contributions, making them accessible to high-income earners.

Ease of Access and Control

Ease of access and control also differs. IRAs are established directly by the individual, offering complete control over the account provider and investment decisions. A 401(k) is employer-established, with participation dependent on employment. While 401(k)s are convenient due to payroll deductions, their portability and investment flexibility are often tied to the employer’s chosen plan.

Combining IRAs and 401(k)s for Retirement Savings

Maximize Contributions

Utilizing both an IRA and a 401(k) significantly enhances retirement savings. This allows individuals to maximize contributions beyond a single account type. For instance, one can contribute the maximum to their 401(k) and still contribute to an IRA, effectively doubling annual tax-advantaged savings. This dual approach accelerates retirement fund growth.

Tax Diversification

Tax diversification is another compelling reason to hold both account types. Contributing to both Traditional (pre-tax) and Roth (after-tax) versions creates a mix of taxable and tax-free assets for retirement. This strategy provides flexibility, allowing withdrawals from either account to manage taxable income and potentially minimize overall tax burden based on future tax rates. This helps hedge against future tax uncertainty.

Leveraging Employer Match

Leveraging the employer match in a 401(k) plan is a fundamental first step. The employer match represents a guaranteed return on investment, often considered “free money.” It is prudent to contribute at least enough to receive the full match before directing funds elsewhere. After securing the full employer match, individuals can allocate additional savings to an IRA, leveraging its unique benefits.

Investment Flexibility

IRAs also provide greater investment flexibility, complementing more limited 401(k) options. If a 401(k) offers a narrow selection, an IRA allows investors to diversify further, access specific asset classes, or invest in individual securities not available in their employer’s plan. This broader control enables individuals to tailor their retirement portfolio to their risk tolerance and financial goals.

Account Rollovers

Account rollovers offer flexibility when individuals change jobs or retire. Funds from a 401(k) can often be rolled over into an IRA, allowing consolidation of retirement assets and continued control over investment choices. This simplifies managing retirement funds, potentially reducing fees and expanding investment opportunities restricted within the previous employer’s plan.

Contribution and Withdrawal Rules

Contribution Rules

Contributions to retirement accounts are governed by specific rules, including income limitations. While anyone with earned income can contribute to a Traditional IRA, contribution deductibility is subject to modified adjusted gross income (MAGI) limits, especially if covered by a workplace retirement plan. For Roth IRAs, direct contributions are phased out for higher income earners, with 2025 MAGI limits for full contributions set at less than $150,000 for single filers and less than $236,000 for married couples filing jointly. There are no age limits for making contributions to Roth or Traditional IRAs, provided earned income. This allows continued saving even past traditional retirement age.

Early Withdrawals

Withdrawals from retirement accounts before age 59½ are generally considered “early” and may incur a 10% penalty in addition to ordinary income tax. However, several exceptions allow penalty-free early withdrawals. These include distributions due to death or total and permanent disability. Other exceptions for both IRAs and 401(k)s may include qualifying medical expenses exceeding a certain percentage of adjusted gross income, and distributions for qualified birth or adoption expenses, limited to $5,000 per child. For IRAs only, penalty-free withdrawals may be permitted for qualified higher education expenses or up to $10,000 for a first-time home purchase. For 401(k)s, a “Rule of 55” exception allows penalty-free withdrawals if an employee leaves their job in the year they turn 55 or later.

Required Minimum Distributions (RMDs)

Required Minimum Distributions (RMDs) mandate that individuals begin withdrawing funds from most tax-deferred retirement accounts once they reach a certain age. For those turning 73 in 2023 or later, RMDs generally begin at age 73. The first RMD must be taken by April 1 of the year following the year the individual turns 73, with subsequent RMDs due by December 31 each year. These rules apply to Traditional IRAs, 401(k)s, and other employer-sponsored plans. Roth IRAs are exempt from RMDs during the original owner’s lifetime, allowing funds to grow tax-free indefinitely. As of 2024, Roth 401(k)s also no longer require RMDs for the original owner. Failure to take a required RMD can result in a penalty, typically 25% of the amount that should have been withdrawn, reducible to 10% if corrected promptly.