In recent years, more and more has been said about the importance of saving for retirement. Watching so many current retirees struggle for cash has left many Americans concerned about saving enough.
According to The Economic Policy Institute, the average family aged 56-61 has only $163,577 in retirement savings. If a 61-year-old with an average balance doesn’t save any more before he retires at age 65, and lives to be 85, he’ll have just $8,178 per year in retirement savings to live off of, not including interest accrual.
The good news is that yes, you can contribute to both a 401(k) and an IRA. Contributing to both types of retirement accounts goes a long way in helping ensure you’ve got enough for retirement.
Let’s go over some basic questions between 401(k)s and IRAs. That way you’ll have enough information to know how to best manage your retirement savings monies.
In This Article
- What is the Difference Between a 401(k) and an IRA?
- What are the Contribution Limits for the 401(k) and IRA?
- What are the Deduction Limits for the 401k and IRA?
- How Much Should I Contribute to Both a 401(k) and IRA?
- Finding Money in Your Budget to Contribute to Retirement Accounts
What is the Difference Between a 401(k) and an IRA?
401(k)s and IRAs are both retirement savings vehicles. However, they each have their differences. And within the IRA family there are even more differences.
For the purposes of this article, we’ll discuss the 401(k), the IRA and the Roth IRA. Those three vehicles make up a majority of retirement savings plans.
The 401(k) is an employer sponsored retirement plan. 401(k)s can only be offered by companies. So, in order to qualify to participate in a 401(k) plan you need to work for an employer that offers that benefit.
Note: if you own your own business you may be able to offer yourself a 401(k) plan as well. A company’s 401(k) accounts are generally held and managed by a custodian such as a bank or brokerage firm.
401(k) monies are generally invested in a variety of different mutual funds as offered by your company’s 401(k) custodian.
Bonus: some companies will match the contributions their employees make to their 401(k) accounts.
For instance, let’s say you as an employee contribute 5 percent of your earnings to your 401(k) account. Your employer may have a program in place where they match 100 percent of contributions up to 3 percent.
As an employee, this means you get an immediate positive return on your contribution. In other words: free money. Not all employers offer this benefit, but if they do it’d be wise to take advantage of it.
Tip: Wondering which funds to put your 401(k) contributions in? Hire Blooom to help you find hidden fees and help you determine which employee-sponsored funds to put your 401(k) money in. Blooom offers objective 401(k) analysis services for just $10 a month!
In most cases, 401(k) contributions are tax-deductible. The 401(k) has a sister plan called a 403(b) plan that is available to public employees such as school teachers.
The Traditional IRA
The Traditional IRA works in many ways like the 401(k). Anyone can open an IRA. There are contribution limits for them (which we’ll talk about later), and they are managed by banks and/or brokerage firms.
In most cases, Traditional IRA contributions are tax deductible.
The Roth IRA
The Roth IRA differs from a Traditional IRA in that its contributions are not tax deductible. However, there’s one potentially major benefit to a Roth IRA; its contributions grow (via investing) tax-free.
So, although you can’t reduce your taxable income by contributing to a Roth IRA, you can grow savings for retirement and not have to pay taxes on those monies when you withdraw them for use (in most cases).
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As you can see, each retirement vehicle has slightly different benefits. Now we’ll talk about what the contribution limits are for each vehicle.
What are the Contribution Limits for the 401(k) and IRA?
Both the IRA and the 401(k) have differing annual contribution limits. Here are the 2018 contribution limits for the 401(k) and for the IRA.
Contribution Limits for the 401k Plan
As of 2018, the contribution limit for 401(k) plans is $18,500 per year. If you are age 50 or above, you’re allowed to make “catch-up” contributions up to $6,000 per year as of 2018.
This means that persons 50 and older technically have a contribution limit of $24,500.
Contribution Limits for IRAs
The IRS contribution limits for IRAs for 2018 are $5,500 per year. For those age 50 and older, additional catch-up contributions of $1,000 per year are allowed.
This brings the total contribution limit for IRAs up to $6,500 per year for those age 50 and above. These limits apply whether you’re contributing to a Traditional IRA, a Roth IRA or both.
Note that there are some other limits to 401(k) and IRA contribution as well. For instance, the IRS has set a limit of $55,000 or maximum compensation, whichever is less, as a combined retirement savings contribution maximum.
However, your employer’s plan may set lesser limits. Check with your benefits center to be sure. Check with an investment specialist or the IRS for income and other limits regarding 401(k) and IRA contributions.
What are the Deduction Limits for the 401k and IRA?
As we discussed briefly earlier, both 401(k) and IRA contributions can be deducted from your taxable earnings in some cases.
Your annual adjusted gross income plays a factor in how much of your contributions you can deduct on your taxes. Remember that Roth IRA contributions are not deductible, but that their earnings grow tax free instead.
Your marital status and how you file your taxes can make a difference as well. The list of deduction limits and rules is too expansive to go over here. For more information, check out the IRS web pages linked to below:
How Much Should I Contribute to Both a 401(k) and IRA?
You might be wondering how much of your income you should contribute to an IRA or 401(k). The answer to that depends on several things.
First, you may want to determine how much money you wish to retire with. The answer to that question depends on a lot of things, but almost all people agree; the more you save, the better.
Even if you don’t plan on living a life of luxury in retirement, for instance, you’ll want to have plenty of cash saved for potential medical costs.
If you have the money to max out contributions to both retirement savings vehicles, you should. At least until you’ve reached a substantial amount of savings, say $1 million or more.
The younger you start contributing to your retirement savings vehicles, the better. If you’re middle-aged or older and lacking in retirement savings, maximizing contributions is vitally important.
Determining 401(k) and IRA Contribution Amounts
As I mentioned above, if you’re behind on retirement savings contributions, you should contribute as much as possible.
If you’re not behind, you can use retirement savings calculators, like the one from Bankrate, that can help you determine how much to contribute each month or year.
These types of calculators help you determine how much money you should save each month. They also show you the potential for growth over the years.
“That may all be fine and dandy, but how am I supposed to find money to save?” you may be asking. In a world where nearly 8 out of 10 Americans live paycheck to paycheck, according to CBS News, finding money to save can be tough.
In the next section, we’ll talk about ways you can find more money to save for retirement.
Finding Money in Your Budget to Contribute to Retirement Accounts
Saving money isn’t always easy. Depending on your income, your debt load and your monthly expenses, you may be finding it difficult to find extra money to save for retirement.
Here are some tips for increasing the amount of money you have to put toward retirement savings.
Make it Automatic
Sometimes all it takes to increase retirement savings is an automatic deduction from your paycheck or bank account. When you “pay yourself first”, there’s something about the mind that automatically adjusts to live in the new, lower income.
If you treat your retirement savings like you would any other bill, you may find it easier to save. Just make it a non-negotiable payment amount like you would your house payment or electric bill.
Not only does this technique do the work for you, (once you set up the auto-withdrawal from your checking account, you’re done), it’ll help you to save more effortlessly.
Create a Plan
In some cases, it can be difficult to be motivated to save for retirement if you don’t have a plan. Without a vision of what you want life to be like 30, 40 or 50 years from now, it can seem like retirement age will never come.
Saving for retirement might become easier if you meet with a financial planner to help make a plan for your future.
You could even meet with a trusted friend or family member who is good with money. Maybe you have a parent, grandparent, aunt or uncle who has established wealth. They may be willing to share their wisdom about how you can better prepare for retirement.
As an additional resource, the Well Kept Wallet You Can Retire Early book can give you advice and wisdom on saving for retirement too – early or not.
Having a plan and a vision for your future may help motivate you to save more for retirement.
Revamp Your Budget
Sometimes finding more money to save for retirement simply takes a re-do of your budget. We suggest trying the Challenge Everything Budget.
The Challenge Everything Budget encourages you to start by writing down every single expense you have. Include housing costs, transportation costs, clothing costs and money for utilities.
Don’t forget to include how much you spend on entertainment and eating out. Include money spent on personal care such as salon trips and gym memberships as well.
After you complete this first step, that’s where the real money-saving fun begins. Now it’s time to assess each line item in your budget.
Look at every expense you have and ask yourself one question: How can I reduce or eliminate this expense? Some expenses such as gym memberships or cable subscriptions might be easy. You just cancel them and move on.
Other expenses might seem more difficult to reduce or eliminate. For instance, you may be able to reduce your car insurance rates, but you might have to shop around to do so. Companies such as Esurance may be able to help you lower your auto insurance rates.
Similarly, you may be able to lower your housing expenses. You could move to a place where the rent is lower, downsize your house or refinance to get a better mortgage rate.
Once you’ve lowered every expense as much as you can, take the monthly monetary savings and designated toward additional 401(k) or IRA contributions. Every little increase will add up to big savings over time.
Saving in both a 401(k) and an IRA if you’re eligible is a great way to maximize retirement savings. And by using the budgeting tips above, you can find even more ways to save for retirement.
Struggling to pay the bills – whether in retirement or out of retirement – is no fun. Make your plan to be sure you have ample retirement savings today. When you’re ready to hit the road to retirement, you’ll be glad you did.
Are you saving in a 401(k), and IRA or both? If not, what’s stopping you? Do you think the tips above may be able to help you save more for retirement? Share your thoughts in the comments below.