all about How To : Can You Contribute to a 401k and an IRA in the Same Year?

Can You Contribute to a 401k and an IRA in the Same Year? Taking advantage of more than one retirement account in the same year allows you to cut taxes and save more money for the future. But in some cases, having an extra retirement account changes the rules and the tax benefits you receive.

In this post, I’ll answer a listener question about contributing to a 401k and an IRA in the same year. You’ll learn the rules for contributing to these accounts simultaneously and pitfalls to avoid so they help you reach your retirement goals.

Free Resource: Retirement Account Comparison Chart (PDF download) - get this handy, one-page resource to understand the different types of retirement accounts.

A podcast listener named Justin says, “I already maxed out my 401(k) for 2017 and after receiving a small inheritance, I now have more money to invest for retirement. Can I also max out an IRA—and if so, would the contribution also be tax-deductible?”

Justin, this is a common question that comes with a slightly complicated answer that I’ll unpack in this post. The good news is that you can always max out a retirement plan at work (like a 401k, 403b, or 457 plan) and still max out an IRA for the same tax year.

For 2017, workplace plans allow you to contribute up to $18,000 or up to $24,000 if you’re 50 or older. If you meet those limits and still have cash to spare, socking even more into an IRA is a wise move.

The IRA contribution limits for 2017 are $5,500 for either a traditional IRA, a Roth IRA, or a combination of both. And if you’re 50 or older, you can contribute an additional $1,000, for a total of $6,500 each year. There are no income limits that prevent you from making contributions to a traditional IRA.

But there’s a tax issue that can trip you up if you’re not aware of it. The bad news is that if you, or a spouse, participate in a retirement plan at work (no matter how much you contribute), the tax deduction for traditional IRA contributions may be reduced or eliminated, depending on your income.

The bad news is that if you, or a spouse, participate in a retirement plan at work (no matter how much you contribute), the tax deduction for traditional IRA contributions may be reduced or eliminated, depending on your income.

What Are Deductible and Non-Deductible Retirement Account Contributions?

First, a quick refresher on the distinction between deductible and non-deductible contributions. Then I’ll review the income thresholds that limit the deductibility of your traditional IRA contributions when you or a spouse also have a workplace retirement plan.

With a traditional retirement account, like a regular 401k or a traditional IRA, you make pre-tax contributions from your paycheck, or you claim them as a deduction on your tax return. These deductible contributions reduce your taxable income and therefore cut the amount of tax you must pay in the year you make them.

In contrast, contributions to a Roth retirement account, such as a Roth 401k or Roth IRA, are always non-deductible because you fund them on an after-tax basis. In other words, you pay tax upfront on Roth contributions and don’t get to claim them as a deduction on your tax return.

Because Roth IRA contributions are not deductible, there’s never a conflict with having one in addition to a workplace account. They complement a retirement plan at work very well.

Problem is, there’s a catch with a Roth IRA for high earners. If you make over a certain amount of income, you’re not allowed to make Roth IRA contributions that year. I’ll cover the income thresholds that lock you out of a Roth IRA in just a moment.

Deducting Traditional IRA Contributions With a Retirement Plan at Work

Getting back to Justin’s question, the deductibility of contributions to a traditional IRA, when you also have a workplace plan, depend on these modified adjusted gross income (MAGI) limits for 2017:

Single taxpayers get a partial deduction when MAGI is between $62,000 and $72,000, but no deduction at or above $72,000.
Married taxpayers who file a joint return get a partial deduction when household MAGI is between $99,000 and $119,000, but no deduction at or above $119,000.
Married taxpayers who file separate returns get a partial deduction when MAGI is less than $10,000 and no deduction at or above $10,000.

So, if Justin is single with income less than about $62,000, he could get a full deduction for his traditional IRA contributions. But if he earns more than $72,000, he’s out of luck. And if Justin is a married guy who files taxes with a spouse, he is unable to claim a deduction if their household income tops $119,000.

If your income is below these thresholds and you want an additional tax deduction for the year, then contributing to a traditional IRA, in addition to your workplace retirement plan is the perfect option.

Deducting Traditional IRA Contributions Without a Retirement Plan at Work

Here’s another situation that affects married people. Let’s say Justin is married to Sarah, who works for a small company that doesn’t offer a retirement plan. Because Justin is covered by a 401k, that limits how much Sarah can deduct for her IRA as well. She can max out an IRA in any year—but the amount she can deduct depends on their household income.

For 2017, if you’re not covered by a retirement plan at work, but your spouse is, the deductibility of your IRA contributions depends on these income limits for 2017:

Married taxpayers who file a joint return get a partial deduction when household MAGI is between $186,000 and $196,000, but no deduction at or above $196,000.
Married taxpayers who file separate returns get a partial deduction when MAGI is less than $10,000 and no deduction at or above $10,000.

Should You Make Non-Deductible IRA Contributions?

You might be thinking, what’s the point of making contributions to a traditional IRA if they don’t come with a full tax deduction? When you make non-deductible contributions to a traditional IRA, the only benefit you get is deferring tax on growth in the account until you make withdrawals in the future. Still a good benefit.

But a downside to having a traditional IRA than contains both deductible and non-deductible contributions is that the recordkeeping gets tricky. So, if you’re not extremely organized or don’t have a tax accountant, I recommend opening a separate traditional IRA that’s just for your non-deductible contributions.

Keeping different types of contributions separate helps prevent any confusion about which funds have already been taxed and which haven’t. If you or your custodian don’t keep it straight, you could end up paying tax on the same funds for a second time in retirement.

To help with the recordkeeping, you’re required to file IRS Form 8606, Nondeductible IRAs when you make non-deductible contributions to a traditional IRA.

Understand Who Qualifies for a Roth IRA

If Justin’s income is too high to qualify for a deductible, traditional IRA and he doesn’t like the idea of making a non-deductible contribution, he should consider a Roth IRA instead. But as I previously mentioned, your income determines whether you qualify for a Roth IRA.

Here are the income limits that prevent you from contributing to a Roth IRA for 2017:

Single taxpayers can’t contribute when MAGI is at or above $133,000.
Married taxpayers who file a joint return can’t contribute when household MAGI is $196,000 or higher.
Married taxpayers who file separate returns can’t contribute when MAGI is $10,000 or higher.

If Justin’s income is above these limits, his only retirement account option would be to max out a traditional IRA with non-deductible contributions. However, if he has business income, he may qualify for a retirement account for the self-employed, such as a SEP-IRA that allows contributions up to $53,000 or 25% of earnings, whichever is less.

Assuming Justin doesn’t have any self-employment income his best bet is to first max out a Roth IRA if he’s eligible, and if not, go with a non-deductible IRA.

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all about How To

Rabu, 05 April 2017

Can You Contribute to a 401k and an IRA in the Same Year?