Making contributions to Roth IRAs and 401(k)s are two of the best ways to prepare for the golden years. Here are some frequently asked questions to help investors decide whether to focus on one or go for both.
In this article:
- Can You Have a Roth IRA and a 401(k)?
- What’s a 401(k) Plan?
- What’s a Roth IRA?
- What Are the Roth IRA and 401(k) Contribution Limits for 2019?
- What Is the Income Limit for Roth IRA Contributions in 2019?
- Is It Better to Invest in a Roth IRA or a 401(K)?
- Do People Need to Make Contributions to Both a 401(k) Plan and a Roth IRA?
Making Contributions to a Roth IRA and a 401(k)
Can You Have a Roth IRA and a 401(k)?
The simplest answer to this is yes, but people who are considering doing it should evaluate further if this is the best strategy for them.
When deciding whether to make contributions to both a Roth IRA and 401(k), it’s important to ask the right questions. Only the right questions can lead to right answers.
What’s a 401(k) Plan?
This is a specific type of retirement savings scheme that’s specific to employees. Employers sponsor their employees’ 401(k) plans, which allows the latter to save and invest parts of their pre-tax income.
Because 401(k) plans are funded by pre-tax income, contributions to this plan can reduce current income taxes owed for the year.
However, taxes will be paid later on when employees withdraw from their 401(k) plans at their current tax rates at the time of withdrawals. This can be a concern later on if owners move up to a higher tax bracket upon withdrawal.
What’s a Roth IRA?
A Roth IRA refers to a kind of retirement account people fund with after-tax income. This means that people can’t use Roth IRA contributions as tax deductions to reduce income taxes owed.
There’s a benefit to funding Roth IRA contributions with tax-deducted income. All qualified future withdrawals from a Roth IRA are tax-free, unlike those from a Traditional IRA.
What are Qualified Withdrawals? These are Roth IRA withdrawals that meet specific conditions, such as age, at the time of withdrawal. Because withdrawals meet such conditions, the IRS doesn’t penalize or tax such withdrawals.
Because qualified future withdrawals are tax-free, Roth IRA owners don’t have to worry if their tax rates go up by the time they withdraw. Hence, Roth IRAs can help owners minimize investment-related taxes by paying taxes now instead of later.
While a Roth IRA may provide tax-free withdrawals in the future compared to a 401(k), it’s more limited than a 401(k). Not everyone can make Roth IRA contributions, and even if they’re qualified, they can’t contribute as much as compared to 401(k) plans.
What Are the Roth IRA and 401(k) Contribution Limits for 2019?
Roth IRA Contribution Limits
Roth IRA owners face two limitations, the first of which is on total annual IRA contributions.
Every year, they can contribute a maximum of $6,000 (total for Roth and Traditional) if they’re below 50 years old. If they’re 50 or older, they can contribute up to $7,000 every year.
Anybody who earns less than these limits can only contribute up to the amount of their annual income. For example, a person who earned $5,000 during the year can only contribute a maximum of $5,000 to a Roth IRA account that year.
401(k) Contribution Limits
On the other hand, 401(k) plan owners can contribute as much as $19,000 annually if they’re younger than 50 years old as of 2019. If they’re 50 or older, they can contribute an additional $6,000 annually or a total of $25,000.
They have the opportunity to have more in their 401(k) plans if they have an employer contribution matching plan wherein the employer also contributes to the employees’ plan.
What Is the Income Limit for Roth IRA Contributions in 2019?
The second limitation Roth IRA owners face is income. People who earn more than the prescribed income limit can’t maximize their annual contributions or even make contributions.
The following are the income contribution limits that Roth IRA owners face:
People who are single, heads of their households, or are married but file taxes separately and lived separately from the spouse during the year
- Annual income doesn’t exceed $122,000 — Can contribute the maximum annual amount of $6,000 ($7,000 if over 50 years old) if annual income doesn’t exceed $122,000.
- Income is over $122,000, but not over $137,000 — If income is over $122,000 but not over $137,000, maximum contributions are reduced.
- Exceeds $137,000 — If income exceeds $137,000, they can’t make IRA contributions.
Qualified widows/widowers or people who are married but file taxes separately
- Annual income doesn’t exceed $193,000 — Can contribute as much as $6,000 ($7,000 if over 50 years old) if they don’t earn more than $193,000 annually.
- Income is over $193,000 but not over $203,000 — If they earn more than that but not more than $203,000, their maximum annual contributions are reduced
- Exceeds $203,000 — They can’t make IRA contributions.
Married people who file taxes separately from their spouse and lived with the spouse during the year
- Annual income doesn’t exceed $10,000 — Can’t maximize the $6,000 or $7,000 contribution limit if they earned any income totaling $10,000 for the year.
- Income is over $10,000 — If they earned more than $10,000, they can’t make contributions.
Is It Better to Invest in a Roth IRA or a 401(K)?
A person’s retirement preferences and goals determine which is the better investment.
- If a person wants to prioritize untaxed withdrawals, a Roth IRA account is the better investment.
- If they want to invest the maximum amount of money possible for retirement, then a 401(k) is better. More so if the 401(k) plan includes matching employer contributions.
Considering that the goal of preparing for retirement is to have as much money as possible during one’s golden years, a 401(k) may be a better investment for many investors. This is because a person can invest more money in a 401(k) plan every year compared to a Roth IRA account.
Do People Need to Make Contributions to Both a 401(k) Plan and a Roth IRA?
No, they don’t. However, making contributions to both can help them maximize their tax-advantaged retirement accounts under the law.
What are Tax-Advantaged Retirement Accounts? These refer to retirement investment accounts that are either tax-deferred, tax-exempt, or enjoy other tax-related benefits, such as Roth IRAs and 401(k) plans.
Contributing to Both 401(k) and Roth IRA
Investors 50 years and older can contribute as much as $25,000 in a 401(k) plan annually. If qualified, they can also contribute as much as $7,000 annually to a Roth IRA, for a total of $32,000.
And, by contributing to a Roth IRA, people can also maximize their tax-free retirement withdrawals.
Contributing to 401(k) Before Making Roth IRA Contributions
However, some investors prefer to max out their 401(k) contributions first before contributing to their Roth IRAs. There are two reasons for this.
- Contribution Limits — 401(k) plans allow them to save up and invest more money for retirement compared to Roth IRAs because the former has higher contribution limits.
- Income Limits — As mentioned earlier, Roth IRA contributions are also subject to a maximum annual income limit. On the other hand, 401(k) plans have no income-related contribution limitations.
Making contributions to both a Roth IRA and 401(k) plan doesn’t just reduce taxes on withdrawals upon retirement. More importantly, it can also maximize the funds available for it. Making contributions to both accounts can be beneficial and provide certain merits to investors.
Are you already making contributions to both retirement accounts? If not, are you considering it? Share your thoughts with us in the comments section below.