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Why to contribute to both a 401(k) & an IRA: Savings & tax benefits

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Two of the most popular retirement savings accounts are the 401(k) and individual retirement account (IRA). How do you choose between the two? Good news— you don't have to!

Because they have different structures and rules, it can be confusing to determine where to invest your retirement savings. You may wonder, "Can I contribute to a 401(k) and an IRA at the same time?" You can own both types of tax-advantaged accounts simultaneously, and, depending on your situation, it could be a savvy move.

Here are some factors to consider about supplementing a 401(k) with an IRA.

Diversifying retirement funds can become more important with age

First, a quick review of the options. A 401(k) is an employer-based plan that you fund through payroll deductions. If your company matches your contributions, that additional money can help further boost your nest egg. An IRA, on the other hand, is an account you can open through a financial institution such as a bank or brokerage firm.

Diversification, the practice of spreading your assets among numerous investments, can reduce the impact of market volatility and other risks. Thrivent's Retirement Readiness 2022 Survey* found that many investors diversify over time. Among those nearing retirement, 42% intend to rely on a mix of assets such as a 401(k), IRAs, personal savings and Social Security benefits. Only 21% of the younger generations of savers have a similar strategy.

It's never too early to start diversifying. Maintaining both a 401(k) and IRA is a great first step, especially since both offer the tremendous benefit of compound interest for your retirement assets.

Adding an IRA can boost your investment options

An IRA gives you the flexibility to include many kinds of assets such as stocks, bonds, mutual funds, certificates of deposit, real-estate investment trusts and money market funds.

Your investment options are usually slimmer with a 401(k), although some plans enable investors to access more choices through a self-directed brokerage account.

Contributing to both 401(k) and IRA affects contribution limits

You can contribute a lot more to a 401(k) each year than an IRA. Funding both simultaneously can help you put more away toward retirement.

401(k) and IRA contribution limits for 2023

  • 401(k): Up to $22,500 ($30,000 if you're 50 or older)
  • IRA: Up to $6,500 ($7,500 if you're 50 or older)

401(k) and IRA contribution limits for 2022

  • 401(k): Up to $20,500 ($27,000 if you're 50 or older)
  • IRA: Up to $6,000 ($7,000 if you're 50 or older)

Contributing the maximum to both retirement accounts can be difficult for many people to afford. You might want to consider waiting to fund an IRA until after you've maxed out your 401(k) contributions or at least taken full advantage of your company match.

There are tax implications if you contribute to a 401(k) and IRA in the same year

Thrivent's Retirement Readiness 2022 Survey found that the most valuable piece of advice people would have given their younger selves would be to learn about the tax implications for their retirement savings.

The two main types of IRAs are usually taxed differently. Whereas a traditional IRA is typically funded with pretax dollars, a Roth IRA is funded with after-tax dollars. These different tax structures create unique considerations when you also contribute to a 401(k).

Contributing to a Roth IRA and 401(k) can be tax efficient

Roth IRAs have income limits based on your modified adjusted gross income (MAGI).

  • For 2023, you may contribute to a Roth IRA if your MAGI is less than $138,000 (single filer) or less than $218,000 (joint filer).
  • For 2022, you may contribute to a Roth IRA if your MAGI is less than $129,000 (single filer) or less than $204,000 (joint filer).

If you meet the income requirements, contributing to a 401(k) and Roth IRA simultaneously can help diversify your tax liability. Here's why: Investments generally trigger taxes, but the timing of the tax bill varies. You can think of investments as being in three buckets: "tax now," "tax later" and "tax never."

Traditional IRAs and 401(k)s typically fall into the "tax later" bucket. You can reduce your taxable income by the amount you contribute to the retirement accounts every year, and any taxes you pay are generally deferred until you begin withdrawals.

Roth IRAs belong to the "tax never" bucket, in which assets generally have preferential income-tax treatment on their accumulated value and distribution. If you follow the IRS's rules for Roth IRAs, your withdrawals are tax-free.

You can use these tax differences between a 401(k) and Roth IRA to your advantage to potentially save more of your money over the long term.

Funding a traditional IRA and 401(k) could impact your tax deduction

As mentioned above, you may be able to deduct your IRA contributions on your taxes. That is certainly true if you and your spouse don't participate in an employer-sponsored plan like a 401(k). If you contribute to a 401(k), however, your IRA contributions would be tax-deductible only if your MAGI is below certain income thresholds.

If your MAGI in 2023 is less than $73,000 for a single filer or less than $116,000 for a joint return ($68,000 or $109,000 in 2022), then your IRA contributions are fully deductible up to the contribution limit - even if you or your spouse also contribute to a 401(k).

If you're an active participant in a 401(k), your IRA contribution deduction is reduced if:

  • MAGI for 2023 is between $73,000 and $83,000 on a single return ($68,000 and $78,000 for 2022)
  • MAGI for 2023 is between $116,000 and $136,000 on a joint return ($109,000 and $129,000 for 2022)

If you're married filing jointly and an active participant in a 401(k) and your spouse is not, the deduction for your spouse's contribution is phased out if:

  • MAGI for 2023 is between $218,000 and $228,000 ($204,000 and $214,000 for 2022)

Although you can still contribute to a IRA, you will not be eligible for the tax deduction if your MAGI exceeds the top of the phase-out thresholds listed above.

RMDs create another tax-related consideration

required minimum distribution (RMD) is the minimum amount you must withdraw from qualifying retirement plans once you reach a specific age. You'll pay income taxes on the distributions.

SECURE Act 2.0 increases the required beginning date (RBD) age to 75 in an incremental phase-in approach over the next 10 years.

· In the case of an individual who attains age 72 after 2022 and age 73 before 2033, the age for starting RMD is age 73

· In the case of an individual who attains age 74 after 2032, the applicable age is 75

A traditional IRA and a 401(k) have an RMD that follow the above RBD requirement, unless you're still working and aren't a 5% owner of the business sponsoring the plan. Some employers choose to offer delayed distribution options as part of their 401(k) plan.

So, if you own both a 401(k) and traditional IRA, you may need to take multiple RMDs in the same year. While you are likely to enjoy the extra income, it can pose a complication: RMDs are taxed at your current income, so the additional income from your distributions could potentially push you into a higher tax bracket.

Roth IRA owners, however, don't need to take RMDs (although they may be required for beneficiaries.) This benefit could be one reason to contribute to a 401(k) and Roth IRA instead of a 401(k) and a traditional IRA.

A dependable expert can help your decision-making

Funding both a 401(k) and an IRA—or even both versions of IRAs—could help maximize your savings ahead of retirement. To make the most of your strategy, consider working with a financial advisor who can guide you through your different account options, their related regulations and how each might fit into realizing the future you envision for yourself and your family.

*Methodology: This research was conducted in June 2022 among a national sample of 1,500 adults in order to measure their sentiments, financial planning, knowledge, and issues regarding retirement. The interviews were conducted online and the data was broken into three sample groups; Saving, Nearing, and Retired. Results from the full survey have a margin of error of plus or minus 3 percentage points.

While diversification can help reduce market risk, it does not eliminate it. Diversification does not assure a profit or protect against loss in a declining market.

Thrivent and its financial advisors and professionals do not provide legal, accounting or tax advice. Consult your attorney or tax professional.

Thrivent financial advisors and professionals have general knowledge of the Social Security tenets. For complete details on your situation, contact the Social Security Administration.