The answer is “yes, but…” The situation can get sticky. We recently helped two new clients uncover it and get unstuck. They were both doing a great job maxing out 401(k) contributions, in addition to saving outside their employer plans. While it might appear they were doing everything right, fantastic even, they were both breaking a rule.
It’s OK to contribute to an IRA and 401(k) at the same time
They are both good earners and good savers. They pay professionals to do their taxes. And they have a goal of extra retirement savings beyond a 401(k). So, in addition to participating in company 401(k)s, they were contributing to Traditional IRAs, too. That’s all well and good.
But IRA contributions may not be tax-deductible
Neither of these people had any idea they were doing anything wrong. The wrongness happened when they deducted those IRA contributions on their tax returns. Why?
The rules are complicated but, in a nutshell, if you are a participating in an employer-sponsored retirement plan like a 401(k), and your modified adjusted gross income (MAGI) is above a certain level, you cannot claim a tax deduction for IRA contributions.
Did they have professional financial advice?
Yes and no. Neither had a comprehensive financial planner and both used “big box store” tax-preparers. Perhaps the tax pro didn’t ask the right questions. Or maybe there was a mistake on a W-2. The point is: If you’re doing beyond-normal savings strategies, you should be getting above-average professional advice.
For these two particular clients, we worked with a CPA for guidance in removing the excess contributions to the IRAs. They paid a small penalty for the misstep, but now everyone can sleep soundly.
What retirement savings strategies could they pursue instead?
For Client #1, because she’s over age 50, and has not taken advantage of the extra catch-up contributions to her 401(k), we’re exploring that option.
For Client #2, we may recommend a Roth IRA for the wife. Or because her spouse is not earning income and their household income is below the threshold, they may be able to contribute to a spousal IRA and take a deduction.
What’s wrong with a non-deductible IRA?
It’s not the worst thing. But, in my opinion, it’s a last-resort. It has the benefit of tax-deferral on the growth but that’s about all it’s got going for it. And it complicates your life because the IRS requires you to continue to track and report the proportion of deductible vs. nondeductible contributions.
Get advice to design your just-right retirement savings strategy
If you’ve maxed out your 401(k) and want to do more, or if your 401(k) is crummy and you’re considering a build-your-own combo of retirement accounts, things can get complicated. There are many ever-changing rules. But with good advice you can put together the just-right savings strategy to save on taxes now and provide nicely for yourself in the future.
If you’d like help designing a retirement savings strategy, click to learn more about Pearl Financial Planning. We help professional women build wealth and dream big.