Maximizing Contributions without Breaking the Rules

You're likely aware of the wisdom in having a retirement fund. But does doubling up on accounts offer double the benefits? Well, it's a bit more nuanced than a simple yes or no. While some combinations of accounts may seem like a perfect match, not all of them play by the rules.

Here, we delve into common questions about which accounts can be paired and when you're better off making a singular choice.

Is it possible to contribute to both a traditional and Roth 401(k) simultaneously?

Certainly, provided your employer offers Roth 401(k) options. However, it's essential to recognize that contributions are capped across both plans. In 2024, people under 50 can put up to $23,000 in total into both accounts, not $23,000 in each account. People over 50 can split their extra contributions ($8,000 in 2024) between traditional and Roth 401(k) accounts.

Why consider splitting contributions between these two accounts? You save on taxes now with a traditional 401(k) and pay no taxes later with a Roth 401(k).

Strategically contributing to both accounts could be beneficial for those who want to manage their tax brackets. If you're uncertain about whether your future tax bracket will be higher or lower, this approach could serve as a form of risk management.

Explore the Roth 401(k). Younger employees may decide to pay taxes now at a lower tax rate. They may anticipate being in a higher tax bracket in the future.

Can you put money into both a 401(k) and an IRA in the same year?

Absolutely. About 32% of people with an individual retirement account also have a 401(k) from their employer.

In 2024, you can contribute a maximum of $23,000 to your 401(k) if you are under 50 years old. If you are 50 or older, the maximum contribution limit is $30,500.

Additionally, you can contribute up to $7,000 to all your IRAs if you are under 50. If you are 50 or older, the maximum contribution limit is $8,000.

Whether your traditional IRA contributions are tax-deductible depends on your income and whether you or your spouse have access to a workplace retirement plan. (Roth IRA contributions do not offer tax deductions.) Income limitations also apply to Roth IRA contributions.

Is it possible to hold 401(k)s from two different employers simultaneously within a single year?

Indeed. Whether you've transitioned between full-time positions or your side gig provides a retirement plan, there could be various reasons for participating in two plans. However, it's crucial not to exceed the annual contribution limit across both plans.

Typically, employers will cease paycheck contributions once you reach the maximum limit. However, if you have multiple employers, they might not be aware of your contributions outside of their respective plans.

If you surpass the limit, it's essential to inform your employer. If you don't correct the extra money before Tax Day next year, you could owe more in taxes. You might also face a 10% penalty for not fixing the mistake.

Additionally, you can maintain both a workplace 401(k) and, if eligible, a self-employed 401(k) concurrently. While employee contribution limits apply across both plans, employers can contribute up to 25% of your compensation. In 2024, the maximum contribution to your retirement account is $69,000. If you are 50 or older and making extra contributions, you can contribute up to $76,500.

Is it permissible to maintain both a traditional IRA and a Roth IRA simultaneously?

Absolutely. Having both traditional and Roth IRAs is important for using a backdoor Roth strategy. This strategy involves converting nondeductible contributions from a traditional IRA into a Roth IRA.

However, it's important to note that contribution limits still apply across both accounts. If you switch money from a traditional IRA to a Roth IRA, you must pay taxes on the amount you switch.

You must split your money between after-tax and pre-tax balances in all of your IRAs. This includes both the contributions you make and the earnings you receive.

For instance, if 90% of your total traditional IRA assets consist of pre-tax funds and 10% are after-tax, you'll need to pay taxes on 90% of the converted amount. Explore more about this pro rata rule for a comprehensive understanding.

Can you put money into both an HSA and an FSA in one year?

Generally, no. But, there's one exception: if you have an HSA with a limited purpose flexible spending account (LPFSA).

An LPFSA is a pre-tax account provided by your employer. It is specifically for dental and vision expenses. You can only have an LPFSA if you have an HSA-eligible health plan.

Are you married? According to the IRS, you and your spouse are viewed as a single tax unit. If your spouse has a health care FSA through their job, you can't contribute to your HSA. Understanding the distinctions between HSAs and FSAs can provide further clarity.

Is it possible to maintain two health insurance plans simultaneously?

Certainly. A process known as coordination of benefits determines the order in which insurance plans will cover expenses.

Your main plan comes first, paying for health expenses up to its limits before the second plan starts to pay.

However, having two plans doesn't necessarily mean you won't incur any out-of-pocket costs. Reducing costs may require paying two premiums and deductibles, along with handling double the paperwork.

Why might someone opt for multiple plans? Sometimes people under 26 have their own work insurance and are also on their parent's plan. Another common scenario is when they have coverage from both their job and their spouse's job.

Is it possible to receive both severance pay and unemployment benefits simultaneously?

The answer varies by state. Some states ban it completely, while others allow it but consider your severance pay when determining lower unemployment benefits. In certain states, double-dipping is allowed because severance pay isn't considered as income.

Laws on severance pay and unemployment benefits differ by state. It's best to check with your state's unemployment office for specific advice.

Is it possible to utilize both the standard deduction and itemize deductions on my tax return?

No, it's not permissible. You need to choose between taking the standard deduction or itemizing deductions. The standard deduction reduces your taxable income by an amount set by the government each year.

Itemizing deductions is for when your deductions are more than the standard deduction. This can lower your taxable income even further. Itemizing is for when your deductions are more than the standard deduction, lowering your taxable income even more.

The IRS has rules about who can use the standard deduction. One group that cannot use it is married individuals filing separately. This applies specifically to those whose spouse itemizes deductions. However, it's typically still feasible to claim credits in addition to the standard deduction.

Can you claim the American Opportunity Tax Credit (AOTC) or Lifetime Learning Credit (LLC) and make tax- and penalty-free withdrawals from a 529 account within the same tax year?

You can't use the same expenses for both the tax-free 529 withdrawal and the tax credit for higher education.

The AOTC pays for the first $2,000 of education expenses and 25% of the next $2,000. This means you can get a maximum credit of $2,500 for $4,000 of expenses.

Let's suppose you have a total of $10,000 in qualified expenses. You can withdraw $6,000 from a 529 account without taxes if you use $4,000 for the AOTC. You can use other funds to cover the remaining amount.

If you take out $10,000 from the 529, the $4,000 that helped you get the AOTC could be considered nonqualified expenses. This might mean you have to pay federal and state taxes, plus a 10% penalty if you already got the AOTC.

Remember, you can only choose either the AOTC or the LLC for the same student in the same tax year. This is as long as they qualify. You cannot choose both.

Bottom Line

Each decision, from balancing contributions between traditional and Roth 401(k)s to juggling health insurance plans and understanding tax implications, requires careful consideration. People can make good choices by thinking about common questions and how each choice affects their money goals and situation. Ultimately, this approach helps people make informed choices that align with their financial objectives. Remember, the path to financial security is paved with thoughtful planning and informed choices.

Sources:
https://www.fidelity.com/learning-center/smart-money/can-i-have-two-health-insurance-plans

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