Why You Should Have Both an IRA and a 401k

For many individuals, preparing for retirement involves navigating various savings vehicles. Individual Retirement Arrangements (IRAs) and employer-sponsored 401(k) plans stand as primary tools for building long-term financial security in the United States. These accounts are widely used to accumulate assets that can support future living expenses. Understanding how both an IRA and a 401(k) function, and how they can complement each other, is a step towards a more robust retirement strategy.

Distinct Features of IRAs and 401(k)s

Employer-sponsored 401(k) plans are retirement savings accounts offered by companies to their employees. These plans typically allow employees to contribute a portion of their pre-tax salary, which can reduce their current taxable income. For 2025, employees can contribute up to $23,500 to a 401(k) plan. Individuals aged 50 and older can contribute an additional $7,500 as a catch-up contribution, raising their limit to $31,000.

Employers often contribute to 401(k) plans through matching contributions, where they contribute a certain amount for each dollar the employee saves, or through profit-sharing contributions. Investment options within a 401(k) are generally curated by the plan administrator, often consisting of a selection of mutual funds or exchange-traded funds (ETFs). Some 401(k) plans also offer loan provisions, allowing participants to borrow against their vested balance under specific terms.

Individual Retirement Arrangements (IRAs), conversely, are personal retirement accounts not tied to an employer. For 2025, individuals can contribute up to $7,000 to an IRA. Those aged 50 and older can make an additional $1,000 catch-up contribution, bringing their annual limit to $8,000. Unlike 401(k)s, IRAs typically offer a much broader range of investment choices, including individual stocks, bonds, mutual funds, and ETFs, providing individuals with greater control over their portfolio composition.

IRAs come in different tax treatments. Traditional IRAs allow contributions to be tax-deductible in the year they are made, depending on income and whether the individual is covered by a workplace retirement plan, with taxes deferred until withdrawal in retirement. Roth IRAs are funded with after-tax dollars, meaning contributions are not tax-deductible, but qualified withdrawals in retirement are entirely tax-free. There are no income limits for contributing to a Traditional IRA, but income can affect the deductibility of contributions. Roth IRAs, however, have specific income limitations that can phase out or eliminate eligibility to contribute directly.

Compelling Reasons for Dual Account Ownership

Holding both an IRA and a 401(k) can allow individuals to contribute significantly more towards retirement savings annually than relying on either account alone. This strategy becomes particularly beneficial for those with higher incomes who seek to save beyond the limits of a single account type.

Utilizing both Traditional and Roth versions across 401(k)s and IRAs offers a strategic advantage for future tax planning, providing flexibility in retirement by creating both taxable and tax-free income streams. For instance, an individual might contribute to a Traditional 401(k) for current tax deductions while also contributing to a Roth IRA to ensure a source of tax-free income in their later years. This mix can help manage tax liabilities in retirement, adapting to unforeseen changes in tax laws or personal financial circumstances.

An IRA typically provides access to a wider array of investment options compared to the more limited choices often found in a 401(k) plan. An IRA allows for greater portfolio customization, including individual stocks or sector-specific investments. This expanded choice enables investors to tailor their portfolios more precisely to their risk tolerance and investment objectives, potentially enhancing overall diversification.

Leveraging employer contributions from a 401(k) is a primary incentive for participation, as these contributions represent a form of compensation that can significantly boost retirement savings. Simultaneously, contributing to an IRA offers personal control and flexibility over additional savings, allowing individuals to select their preferred investments and manage their account independently of employer-sponsored plans.

For individuals whose income exceeds the limits for direct Roth IRA contributions, strategies like the “backdoor Roth IRA” can still enable them to benefit from tax-free growth and withdrawals. This involves making non-deductible contributions to a Traditional IRA and then converting those funds to a Roth IRA.

IRAs also offer greater portability when individuals change jobs. Funds accumulated in a former employer’s 401(k) plan can typically be rolled over into an IRA, providing continued control over investments and avoiding potential fees or limited options within a new employer’s plan.

Navigating Contributions and Distributions

When managing contributions to both a 401(k) and an IRA, a common strategy involves prioritizing contributions to maximize employer matching funds in the 401(k) first. This ensures an immediate, guaranteed return on investment from the employer’s contribution. After securing the full match, individuals might then focus on maximizing their IRA contributions, taking advantage of the broader investment choices and potential tax benefits. Subsequently, if additional funds are available, the focus can shift back to maximizing the 401(k) contributions up to its annual limit.

Being covered by a workplace retirement plan, such as a 401(k), can impact the deductibility of Traditional IRA contributions. For 2025, single filers covered by a workplace plan may have their Traditional IRA deduction phased out with a modified adjusted gross income (MAGI) between $79,000 and $89,000. For married couples filing jointly where the spouse making the IRA contribution is covered by a plan, the phase-out range is between $126,000 and $146,000.

Roth IRA contribution eligibility also depends on income. For 2025, single filers can make a full Roth IRA contribution if their MAGI is less than $150,000, with contributions phasing out between $150,000 and $165,000. Married couples filing jointly can make a full contribution if their MAGI is less than $236,000, with the phase-out range between $236,000 and $246,000.

Withdrawals from both 401(k)s and IRAs generally become penalty-free after age 59½. Taking distributions before this age typically incurs a 10% early withdrawal penalty, in addition to ordinary income taxes on the withdrawn amount. However, several exceptions can allow penalty-free early withdrawals. These include withdrawals for certain unreimbursed medical expenses, qualified higher education expenses, or up to $10,000 for a first-time home purchase from an IRA. Additionally, 401(k) plans may permit penalty-free withdrawals if an employee separates from service in the year they turn age 55 or later.

Both 401(k)s and IRAs are subject to Required Minimum Distributions (RMDs), which generally mandate that account holders begin withdrawing funds once they reach a certain age, currently 73. These rules ensure that deferred taxes on Traditional account balances are eventually collected by the government. The calculation of RMDs depends on the account balance and the account holder’s life expectancy.

When individuals change jobs, rolling over funds from an old 401(k) into an IRA is a common practice. This process allows the funds to continue growing tax-deferred or tax-free, depending on the IRA type. A direct rollover, where funds are transferred directly between financial institutions, helps avoid potential tax withholding and the risk of the 60-day indirect rollover rule.