The Traditional IRA vs. the 401(k) Plan

Financial bloggers often portray the traditional IRA vs. the 401(k) plan as a debate, as if one plan is better than the other.

In truth, they’re very different plans, and they fill very different needs. If you can, you should plan to have both.

This is especially true if your 401(k) plan is fairly restrictive. A lot of them are. They charge high fees and offer very limited investment options. A traditional IRA is often the best strategy to work around those limits.

Let’s take a deep look at both plans, and particularly at where each stands out. I think you’ll agree having both makes a lot of sense. It’s one of the best strategies to supercharge your retirement savings, especially for early retirement.

How the Traditional IRA Works

Here are the basics:

IRA contribution limits. You can contribute up to $6500 per year, or $7500 if you’re age 50 or older. Contributions must be made out of earned income only. That means wages, salary, commissions, self-employment income, or contract income. It does not include income from unearned sources, like pensions, Social Security, or investment income.

For example, if you earn $40,000, and only $4,000 is from earned sources, your IRA contribution will be limited to no more than $4,000.

Spousal IRA provision. If you’re married filing jointly, and either you or your spouse has earned income, and the other doesn’t, you may be eligible to make a spousal IRA contribution. The only requirement is that the spouse with earned income must have sufficient earned income to cover contributions to both plans.

For example, let’s say you earn $50,000 per year, and your spouse is unemployed. You can make a $6,500 contribution to your own IRA, and a $6,500 contribution to a spousal IRA for your spouse. That will give you a combined contribution of $13,000, which will also be fully tax-deductible.