When you put your money into both a 401(k) account and a Roth IRA, it provides an ideal mix of tax savings – some now and some in the future. Roth IRA contributions are made with after-tax dollars, so there is no conflict between this type of plan and a traditional 401(k) account that is funded with pre-tax dollars.
Tax Factors and Distributions
A Roth IRA is a great option if you are already regularly saving in a 401(k) account and looking for a way to save more. Taxes will be owed on the money in the 401(k) account when you withdraw it, because you did not pay taxes on your contributions. Roth IRA distributions are tax-free on contributions, because you have already paid taxes on that money.
Note: The tax-deferred growth of a 401(k) account is postponed until you withdraw it in retirement. Roth IRA earnings are not taxed in most cases if you have held the account for at least five years and are age 59 and a half or older.
A Roth IRA can also be a great option for other goals, such as buying a home or paying for your child’s college expenses. You can withdraw the value of your contributions to the Roth IRA at any time without any taxes or penalties, because you already paid taxes on that money when you earned it.
You must begin taking required minimum distributions (RMDs) from your 401(k) or traditional (non-Roth) IRA account when you reach age 72 (if you turned 70½ before January 1, 2020). However, there are no required minimum distributions from a Roth IRA even after the owner’s death. Beneficiaries of the account may be required to take RMDs to avoid penalties.
Eligibility and Contribution Limits
There are no adjusted gross income (MAGI) limits for contributing to a 401(k), so you can benefit from this type of account, regardless of how much money you earn. You may not be able to contribute the full annual amount allowed for a Roth IRA, or you may not be able to contribute at all if you earn above certain MAGI limits.
Your contribution amount also depends on your tax filing status.
Other Retirement Accounts
You can save money in both a traditional IRA and a Roth IRA if you do not have a 401(k) through work, as long as your combined savings do not exceed the annual limit for 2022, which is $6,000 or $7,000.
It may not make sense to contribute to both a traditional IRA and a 401(k) in the same year, as these two types of accounts are designed to do the same thing. The only difference is that IRAs have much lower contribution limits than 401(k)s.
Note: You can contribute to a small business retirement plan, such as a SEP IRA, if you earn income from self-employment or contract work.
How Much to Save
It is wise to fully take advantage of any employer matching contributions in the work plan before putting money into an IRA. Save at least the same percentage of contribution that your employer matches if they match your contributions in a 401(k).
A good rule of thumb is to save 10% to 15% of pre-tax income. Consider maximizing your Roth IRA after you reach this point, or at least putting in as much as you can into this type of account throughout the year. The tax benefits will compensate, especially if you expect your income tax rates to rise over time.
Questions
Repeating
What is the difference between a Roth IRA and a 401(k) account?
Both an IRA and a 401(k) account are means to save for retirement. A Roth IRA is an account opened by an individual, allowing you to save money after taxes for tax-free withdrawals in retirement. Whether you can contribute to a Roth IRA depends on your income. A 401(k) account is provided by an employer. You contribute pre-tax money to a 401(k), and your employer may also contribute. These contributions reduce your taxable income.
What is the difference between a Roth IRA and a traditional IRA?
Both types of IRA accounts allow you to save money for retirement. A Roth IRA allows you to save money after taxes, and you must meet income requirements to contribute. You can withdraw that money tax-free in retirement. A traditional IRA allows you to save money before taxes, and you may be able to deduct your contributions, depending on your income and whether you or your spouse have retirement plans at work. You pay taxes on withdrawals in retirement.
Was this information helpful?
Thank you for your feedback!
Let us know why!
Sources:
Internal Revenue Service. “Publication 590-B, Distributions From Individual Retirement Arrangements (IRAs),” Page 30.
Internal Revenue Service. “RMD Comparison Chart (IRAs vs. Defined Contribution Plans).”
Internal Revenue Service. “2022 Limitations Adjusted as Provided in Section 415(d), Etc.,” Pages 2, 4.
Internal Revenue Service. “401(k) Plans – Deferrals and Matching When Compensation Exceeds the Annual Limit.”
Internal Revenue Service. “Retirement Topics – IRA Contribution Limits.”
Internal Revenue Service. “IRS Announces 401(k) Limit Increases to $20,500.”
Source: https://www.thebalancemoney.com/saving-in-both-a-401-k-and-a-roth-ira-2894514
Leave a Reply