Can I contribute to a 401(k) and a traditional or Roth IRA? Many people have more than one retirement account. Maximize your retirement savings by understanding how you can contribute to multiple tax-advantaged retirement accounts.
You’ve likely heard this all before about saving for retirement: Start saving as early as possible.
You may have been advised to pay yourself first with automatic retirement contributions, contribute to your employer’s 401(k) plan if one is available, open individual retirement accounts (IRAs), and make sure your portfolio is tailored to your goals and risk tolerance.
Taking advantage of an IRA and 401(k) sounds like great advice, but it may be confusing to decide exactly how to go about doing it all and which retirement-saving moves should take priority over others.
You don’t have to decide on only one route when it comes to taking advantage of retirement savings tools, but some investors may want to prioritize their moves to get the most benefit.
Below, we’ll show you a three-step plan for contributing to both an IRA and 401(k) in a way that can maximize multiple tax-advantaged retirement contributions. Remember, however, that the rules in place today on issues like 401(k) contribution limits and IRA contribution limits are likely to change over the years.
If your employer offers a 401(k) with a matching contribution, financial advisors recommend you take advantage of it. An employee match on your contribution can be considered “free money,” and who wants to leave a freebie on the table?
The amount of the matching funds you receive depends on what your employer offers. Oftentimes, this contribution is tied to your longevity at the company and may be on a “vesting schedule,” which gives employees full ownership of their funds over time. Vesting schedules aim to provide a financial incentive to an employee to stay with a company.
So, it’s important to know the specifics of your company’s 401(k) contribution plan, including what percentage of your salary it will match and how long it may take for you to have the rights to those matching contributions.
There are no income restrictions for participating, but there are limits on how much you can contribute, according to the Internal Revenue Service (IRS):
Remember this, too: Your employer’s matching contribution doesn’t count toward the annual limit. Consider contributing enough to at least get your company match. And if you get a raise or a bonus, you might want to earmark a portion to your retirement account.
The amount you contribute to a traditional 401(k) is taken out of your paycheck on a pre-tax basis, thereby reducing your taxable income. However, when you withdraw those funds, you’ll have to pay taxes on gains. Alternatively, a Roth 401(k) taxes your contributions as income when you make the initial deposit, but then you may withdraw those funds tax-free, not matter how much you’ve made in gains.
When deciding between a traditional 401(k) or a Roth 401(k), the choice is between deferring the taxes until the money is withdrawn in retirement, or paying federal taxes up front but never again.
Can I Have both a 401(k) and an IRA?
Once you've planned to contribute at least the maximum employer-matching amount to your 401(k), you can consider your next set of choices. You may want to continue contributing up to the contribution limit, or you may want to use an IRA, which would not be related to your place of employment as a 401(k) is.
Even if you contribute the maximum to a work-sponsored 401(k) or a similar plan, you may still be able to contribute the full amount to an IRA. However, if it's a traditional IRA, such a contribution might not be tax deductible. For more on contribution limits, read this 2019 update.
If you contribute to a Roth IRA, you need to be under a certain income limit.
Like a 401(k), IRAs offer one of two different tax advantages. Any contributions you make to a traditional IRA may be tax deductible depending on your adjusted gross income. Roth IRAs, on the other hand, are not tax deductible immediately, but you may withdraw those funds, including any gains, tax-free during your retirement years.
However, if you earn over a certain amount, you may not be able to open a Roth IRA account. Roth IRAs have an income threshold for contributions, but not one that’s bound by an employer’s retirement plan contributions. Contribution eligibility is determined by your modified adjusted gross income.
Your contribution can be reduced or phased out if your income reaches certain levels. For 2019, the phaseout begins at $122,000 for single filers ($193,000 for married couples) and the income cap is $137,000 for single filers (and $203,000 for married couples filing jointly).
Remember, you can never contribute more than your annual income. For example, if you earned $4,000, the most you can contribute to an IRA account is that amount. Contributions for nonworking spouses are based on the income of the working spouse.
Essentially, to decide whether a traditional IRA or Roth IRA is best for your retirement goals, learn about the tax consequences of each account.
Again, traditional IRAs are tax deferred. That means you pay the taxes on interest or gains when the funds are withdrawn during retirement. Roth IRAs are funded with post-tax dollars, so you’re not taxed (even on account earnings) once the money comes back to you if the distribution is qualified.
Investors with longer time horizons to allow their funds to grow often benefit from the long-term tax advantages of a Roth account, because investment gains can compound over time and more easily offset any taxes paid when you make the contribution. And investors with shorter investing horizons or investors who need the benefit of tax advantages immediately may prefer traditional IRAs.
Because they’re on separate sides of the tax spectrum, traditional and Roth IRAs can play off each other in retirement. Having a combination of taxable and tax-free income may help you create a withdrawal plan that might potentially minimize your tax bill.
You’ll need to start taking required minimum distributions from your traditional IRA once you turn 70 1/2, but this rule doesn’t apply to Roth IRAs. That means that your money can stay invested longer with a Roth IRA.
There’s one caveat to owning and investing in more than one IRA: The annual limits on your contributions are cumulative between all IRAs you fund, not each individual one. You can split your contributions any way you want as long as you don’t exceed the annual limit and meet the income rules. For example, if you contribute the full $6,000 to a traditional IRA, you can’t contribute to a Roth IRA in 2019.
Remember that pulling money out of your IRA and 401(k) early can be a pricey proposition:
Depending upon what period of your life the funds are withdrawn from your IRA and 401(k), the opportunity costs of pulling money out early could put a big dent in your retirement nest egg because those assets are no longer growing tax deferred. (There are exceptions. Check with a qualified financial planner for guidance.)
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