Retirement

If I Have a 401(k), Why Do I Need an IRA?

MAR 18 | 2022
Woman looking out of window.

You’ve done everything right to begin saving for retirement: You enrolled in your company 401(k) plan and contributed enough from each paycheck to earn the maximum in matching funds from your employer. But if you want to increase your retirement savings, an IRA might be a good option for you.

Investing in your company’s 401(k) plan is one of the easiest ways to save for retirement. Many employers make the process simple. A new employee package typically includes information on how to sign up for the plan and decide how much they want to contribute from each paycheck. And contributing to a qualified retirement plan is a smart move because it can reduce the amount of taxes you owe for the year.

For beginning investors, an employer-based plan is often the first introduction to saving for retirement. And for many American employees, an employer plan will be the only type of retirement account they’ll ever have.

Relying on an employer plan alone, however, can prevent you from maximizing the money available for your retirement. Individual Retirement Accounts (IRAs) can provide additional income when you stop working. And you can gain more tax benefits through annual contributions. 

Traditional IRA

A tax-advantaged personal savings plan where contributions may be tax deductible.

401(k)

A tax-advantaged employer-based savings plan that allows employees to contribute a portion of their wages to individual accounts.

What’s the Difference Between an IRA and a 401(k)?

IRAs let you save for retirement outside of an employer plan. With an IRA, investors under 50 can put up to $6,000 per year in an IRA (in 2022). Those 50 and over can put in an additional $1,000 each year, commonly called a “catch-up contribution.”

IRAs can also offer other tax advantages and benefits. With a traditional IRA, withdrawals (which consist of your contributions and all earnings) after age 59½ are taxed as current income, although you can generally deduct your contribution on your income taxes. With a Roth IRA, you can contribute after-tax income, but all withdrawals after age 59½ are tax free if you’ve had a Roth IRA (not just the account you're withdrawing from) for at least five years.

There are IRS-determined income limits for “deductible” IRA contributions if you also have a 401(k) plan through your employer. That’s why it’s important to consider your household income and likely contributions when deciding between a traditional or Roth IRA.

You can also open an IRA by rolling over a 401(k) account from a previous employer instead of letting it sit with your old company. You’ll face no tax penalties if you transfer that plan to an IRA. You may also enjoy greater flexibility with your IRA transactions.

Can You Have an IRA and a 401(k) at the Same Time?

Yes! You can contribute to both an IRA and 401(k). But consider enrolling in your employer’s 401(k) first. Many employers will match 401(k) contributions up to a certain point.

If your company matches up to 5% on 401(k) contributions, for example, don’t miss out on free money by only contributing 3%. Some companies also increase the match percentage as a perk of longer-term employment. Be sure to understand all your options.

3% of your own contributions + 3% employer match = 6% invested each pay period

5% of your own contributions + 5% employer match = 10% invested each pay period

Making the most of your 401(k) plan is important. It allows you to invest for your future directly from your paycheck and gives you additional money in the process if your employer matches contributions. For many employees, especially younger entry-level and early career workers, contributing to a 401(k) plan might be the only financially accessible way to save for retirement.

But let’s say you’re already doing the basics and want to start putting aside more thanks to a raise, debt payoff, or just a change in financial goals. Or your employer doesn’t offer matching funds and you’d like to consider a broader range of investment vehicles. This is when adding an IRA might be a better choice when considering an IRA versus a 401(k) alone.

The Bottom Line

Most people need 70%–80% of their pre-retirement income to maintain a similar lifestyle during retirement. Consider your goals, too, which may include purchasing a vacation home or paying for grandchildren’s education. You could find your dreams limited if money saved in a 401(k) plan proves not to be enough.

Boosting retirement savings with an IRA can help you contribute more toward a secure retirement.

Need Help With Your Retirement Strategy?

Let's talk.

IRS Circular 230 Disclosure: American Century Companies, Inc. and its affiliates do not provide tax advice. Accordingly, any discussion of U.S. tax matters contained herein (including any attachments) is not intended or written to be used, and cannot be used, in connection with the promotion, marketing or recommendation by anyone unaffiliated with American Century Companies, Inc. of any of the matters addressed herein or for the purpose of avoiding U.S. tax-related penalties.

This information is for educational purposes only and is not intended as tax advice. Please consult your tax advisor for more detailed information or for advice regarding your individual situation.

You could lose money by investing in a mutual fund, even if through your employer's plan or an IRA. An investment in a mutual fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency.

Please consult your tax advisor for more detailed information regarding the Roth IRA or for advice regarding your individual situation.

Taxes are deferred until withdrawal if the requirements are met. A 10% penalty may be imposed for withdrawal prior to reaching age 59½.

This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.