Should You Have an IRA and a 401(k)?

Saving for retirement is a fundamental aspect of financial stability, allowing individuals to secure their future. Effective planning involves understanding various savings vehicles, including employer-sponsored plans and individual arrangements, which offer unique advantages for accumulating wealth.

Understanding IRAs and 401(k)s

A 401(k) is an employer-sponsored retirement savings plan. Contributions to a traditional 401(k) are typically made with pre-tax dollars, reducing current taxable income. A Roth 401(k) allows for after-tax contributions and potentially tax-free withdrawals in retirement.

For 2025, employees can contribute up to $23,500 to a 401(k), with those aged 50 and older eligible for an additional catch-up contribution of $7,500, totaling $31,000. Many employers also offer matching contributions, providing additional funds to an employee’s retirement account. Investment options within a 401(k) are curated by the employer, offering a limited selection of funds.

An Individual Retirement Arrangement (IRA) is a personal retirement savings account. IRAs come in two primary forms: Traditional and Roth. Traditional IRA contributions may be tax-deductible, leading to tax-deferred growth, with withdrawals taxed in retirement. Roth IRA contributions are made with after-tax dollars, allowing for tax-free growth and qualified tax-free withdrawals in retirement.

For 2025, the contribution limit for an IRA is $7,000 for individuals under age 50, and $8,000 for those aged 50 and older. Unlike 401(k)s, IRAs offer a wider array of investment choices, providing greater control over portfolio construction, including individual stocks, bonds, mutual funds, and exchange-traded funds.

The distinction between these account types lies in their sponsorship and investment flexibility. A 401(k) is tied to employment and often includes employer contributions, while an IRA is an individual account, offering more autonomy. While 401(k)s benefit from higher contribution limits and potential employer matches, IRAs provide a diverse range of investment opportunities and direct personal control.

Advantages of Having Both

Maintaining both a 401(k) and an IRA offers several financial benefits for retirement planning. One advantage is the ability to increase overall annual savings. Since contribution limits for 401(k)s and IRAs are independent, individuals can contribute the maximum to both, accelerating wealth accumulation. This dual contribution strategy allows for a larger sum to be set aside each year.

Another benefit is tax diversification, which provides flexibility in managing tax liabilities during retirement. By contributing to both pre-tax and after-tax accounts, individuals create income streams taxed differently in the future. This allows retirees to strategically withdraw funds from either taxable or tax-free accounts, depending on their income level and prevailing tax rates. This approach can help manage overall taxable income in retirement.

Having both account types also broadens investment flexibility. While a 401(k) plan offers a limited selection of investment options, an IRA provides access to a wider universe of investments. This expanded choice allows investors to tailor their portfolio more precisely to their risk tolerance and financial goals.

Furthermore, holding both accounts ensures access to an employer’s 401(k) match. Maximizing this match is a priority, as it immediately boosts savings without additional personal investment. After securing the full employer match, utilizing an IRA for additional savings provides flexibility and greater investment control beyond the employer-sponsored plan. This dual approach combines employer contributions with personalized investment opportunities.

Coordinating Contributions and Withdrawals

Managing contributions to both a 401(k) and an IRA maximizes savings and tax advantages. A common strategy prioritizes contributing enough to a 401(k) to receive the full employer match. After securing the employer match, many individuals focus on fully funding an IRA, particularly a Roth IRA, due to its potential for tax-free withdrawals in retirement. Once the IRA is maximized, the next step is to contribute additional funds to the 401(k) up to its annual limit, further boosting tax-deferred or tax-free growth.

For high-income earners whose modified adjusted gross income (MAGI) exceeds the limits for direct Roth IRA contributions, a “backdoor Roth” strategy can be employed. This involves making a non-deductible contribution to a Traditional IRA and then converting those funds to a Roth IRA. This process allows high earners to access Roth benefits.

Individuals can roll over funds from an old 401(k) to an IRA, which can consolidate retirement assets and provide greater investment control. A direct rollover from a Traditional 401(k) to a Traditional IRA is a tax-free event. Converting a Traditional 401(k) or Traditional IRA to a Roth IRA is a taxable event, as previously untaxed funds become subject to income tax in the year of conversion. Some 401(k) plans permit “reverse rollovers” where IRA funds can be moved into the 401(k).

Distributions from Traditional 401(k)s and Traditional IRAs are taxed as ordinary income in the year they are received, as contributions were made pre-tax or tax-deductible. Withdrawals made before age 59½ incur a 10% early withdrawal penalty, in addition to regular income taxes. For Roth accounts, qualified withdrawals are entirely tax-free, provided the account holder is at least 59½ years old and the account has been open for at least five years.

Required Minimum Distributions (RMDs) mandate withdrawals from Traditional IRAs and 401(k)s starting at age 73. Roth IRAs are not subject to RMDs for the original owner’s lifetime, offering greater flexibility in managing tax liability in later years. As of 2024, Roth 401(k)s are also exempt from RMDs for the original owner. This flexibility allows retirees to strategically draw from different account types to manage their taxable income and defer taxes on certain assets for longer periods.