Can You Invest in Both an IRA and a 401k?

by Michael Keenan ; Updated July 27, 2017

The Internal Revenue Service does not bar anyone from making contributions to both an individual retirement plan and a 401k plan as long as you meet both plans' eligibility requirements. However, your ability to take advantage of the tax deduction for traditional IRAs may be compromised by your ability to contribute to a 401k plan.

Requirements

To contribute to a traditional IRA, you must be under 70 1/2 years old at the end of the year. To contribute to a Roth IRA, your modified adjusted gross income has to be lower than the limit for your filing status. Both types of IRAs require you to have earned income for the year. To participate in a 401k plan, you have to work for an employer that offers you the ability to participate in the plan.

Traditional IRA Deductions

A 401k plan counts as an employer-sponsored plan for the purposes of determining whether you can deduct your traditional IRA contribution. If your Modified Adjusted Gross Income exceeds the limit for your filing status, the IRS still permits you to contribute to a traditional IRA, but requires that the contributions that you make be nondeductible contributions. The MAGI limit differs depending on your filing status: married couples filing jointly have higher limits than singles. Married couples filing separately have the lowest limits.

Alternatives to Nondeductible Traditional IRA Contributions

If your modified adjusted gross income falls below the annual limits for Roth IRA contributions, consider making a Roth IRA contribution instead of a nondeductible traditional IRA contribution because both the contributions and earnings come out tax-free at retirement from a Roth IRA. If your income exceeds the MAGI limits for Roth IRA contributions, you can also make a nondeductible contribution to a traditional IRA then convert the money to a Roth IRA because the IRS does not restrict IRA conversions based on income. If you make a conversion, your nondeductible contributions will not count as taxable income, but any earnings accrued while the money was in the traditional IRA counts as taxable income.

Matching Considerations

If you do not have enough extra income to fully fund both your IRA and your 401k plan, consider if your employer offers a matching contribution. If so, consider taking full advantage of this before funding your IRA. For example, if your employer offers a dollar for dollar match up to $7,000 per year, if you put $7,000 in your 401k plan, your company also puts in $7,000, giving you $14,000 total. Even though your 401k plan may offer fewer investment options, if you do not take advantage of the matching contributions, you decline free money from your employer.

About the Author

Mark Kennan is a writer based in the Kansas City area, specializing in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."