Can You Open an IRA if You Have a 401k?

Individual retirement plans and 401k plans enable individuals to invest money for retirement. The Internal Revenue Service allows funds inside the plans to grow tax deferred, and allows people to invest in both types of plan if they met eligibility requirements. Many companies match employee contributions to 401k plans, making them more popular than other types of retirement instruments.

Types Of IRA

• Traditional IRAs contain money not yet exposed to ordinary income tax. The IRS deducts the amount of annual contributions from people's taxable income. Funds grow tax deferred, and the IRS assesses income tax on both principal and interest when the owner makes withdrawals.

  Roth IRAs contain already taxed earnings. Roth IRAs grow tax-sheltered, and no taxes are due on principal or interest when the owner makes withdrawals unless they occur before age 59 1/2.

Time Frame

• People with earned income can make Roth IRA, traditional IRA and 401k contributions. If investors make withdrawals from the plans prior to age 59 1/2, they incur a 10 percent premature withdrawal penalty. The IRS requires plan administrators to withhold an additional 20 percent of withdrawal amounts to cover ordinary income tax. The IRS requires people to begin making withdrawals from traditional IRA accounts no later than age 70 1/2.

Misconceptions

• Many people believe that Roth IRA contributions and 401k contributions are related in terms of income tax treatment. Because Roth IRAs involve taxed earnings, and 401k accounts contain pretax earnings, people can invest in both to the maximum allowed in their tax bracket. The IRS revises guidelines each year, but maximum contributions as of 2010 are $16,500 for 401k plans, and $5,000 for Roth IRA plans. People with income in excess of $100,000 face contribution restrictions and should consult tax professionals.

Warning

• 401k plan contributions and traditional IRA contributions are categorized together under IRS rules. People who meet income eligibility guidelines, who are not covered by 401k plans, can contribute $5,000 to traditional IRA plans per year, or $6,000 if over the age of 50. As of 2010, single people earning less than $55,000, or married people earning less than $89,000, could make full traditional IRA contributions in addition to 401k contributions. Some people earning more, can make reduced contributions, although most high earners cannot contribute to both plans.

Considerations

• Many people face complicated situations with taxation because their circumstances change during the fiscal year. If a company files bankruptcy, the IRS allows otherwise ineligible 401k plan participants to make traditional IRA contributions. The IRS also makes some allowances for people who have access to 401k plans for part of the year, and military reservists who experience breaks in employment. Always consult a tax professional to seek advice for your particular situation.