Investing in both a 401(k) and Roth IRA can be a powerful combo for any retirement savings plan. That is, if you’re eligible. Here’s what to know about qualifying for a Roth IRA and how opening one in addition to an employer-sponsored 401(k) plan can build up a sizable nest egg.
A financial advisor could help you create a financial plan for your retirement needs and goals.
Can I Open and Contribute to Both Accounts?
In short: yes. As long as you meet the eligibility requirements, you’re able to contribute to both a 401(k) and Roth IRA. In fact, building up your savings in both can help maximize your income in retirement.
It can also be a smart strategy because of the way taxes on the accounts are paid. A 401(k) is tax-deferred, meaning you contribute pre-tax income and pay taxes on that money later, when you withdraw it. In contrast, Roth IRA contributions are made with after-tax dollars, so you won’t have to pay taxes when you withdraw it later on.
However, it’s generally advised that you contribute enough to your 401(k) to take full advantage of employer-matched contributions, if offered, before opening a Roth IRA.
In Brief: 401(k) Plans
You can only open a 401(k) account if your workplace offers one. But unlike other retirement savings plans, 401(k)s don’t have income restrictions — which means you could make half a million dollars and still contribute to a plan. There are, however, limits on how much you can contribute.
According to the IRS, in 2022 you can contribute up to $20,500 to a 401(k) plan. (Older workers over 50 are allowed to contribute an extra $6,500 per year.) Note that any match your employer contributes does not count toward these individual limits.
Speaking of matches, if your employer offers one, it’s in your interest to take full advantage. Many employers will match a percentage of your contribution up to a certain amount. The most generous of them will match 100% of your contribution, while others may offer a 50% match.
For example, if you make $100,000 and contribute 6% of your salary, you will have saved $6,000 in a year. An employer match of 100% would increase that total to $12,000. If your employer matches 50% of your contribution, then you’ll instead have invested $9,000 in your 401(k) account.
With a 401(k), you’re obligated to begin taking required minimum distributions (RMDs) once you reach the age of 70½ — even if you don’t need the funds. And since a 401(k) doesn’t tax your contributions during your working years, you’ll have to start paying taxes when you withdraw from the account.
In Brief: Roth IRAs
A Roth IRA is an individual retirement account and, as long as you pay taxes on the income you earn, virtually anyone can open one. In other words, a Roth IRA is not tied to your employer, like a 401(k) plan is. (Note, though, that your workplace may offer a Roth 401(k), which has attributes of both a 401(k) and a Roth IRA.)
The IRS does put income limits on who’s eligible for a Roth IRA, however. For example, a single person can’t make more than $129,000 in 2022 to qualify; married couples filing jointly can’t earn more than a combined $204,000.
As of 2022, you’re allowed to contribute up to $6,000 per year to a Roth IRA (or $7,000 for taxpayers older than 50).
A Roth IRA confers some tax advantages and more flexibility when it comes to withdrawing the money. Since you contribute after-tax dollars to the account, your distributions in retirement won’t be taxed at all, provided you’ve had the account for at least five years and you’re older than 59½. That said, you can withdraw your contributions (but not any profits you’ve earned) at any time tax- and penalty-free. This might come in handy if you need money for a down payment on a house, for example, or unexpectedly face a financial emergency.
Another advantage of a Roth IRA that sets it apart from a 401(k) is that you aren’t required to take distributions in retirement. So if you don’t need the money in the account, you can pass it on to your children or make a charitable donation.
401(k)s and Roth IRAs are excellent choices for saving for the future — and if you’re able to, opening both is a power move toward maximizing your retirement income. But while each offers tax benefits, one may be better for you than the other depending on your circumstances.
Generally speaking, if you expect to be in a higher tax bracket when you retire, a Roth IRA may be a better option because you will have already paid the taxes at the time of your contributions. On the other hand, even though you’ll have to pay taxes on your 401(k) distributions in retirement, these accounts let you save more per year — especially if your employer offers matching contributions.
Tips for Getting Retirement-Ready
- Consider working with a financial advisor to help you meet your retirement goals. Finding one who fits your needs doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors in your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Figure out how much you need to save to retire comfortably. An easy way to get ahead on saving for retirement is by taking advantage of employer 401(k) matching.
Photo credit: ©iStock.com/courtneyk, ©iStock.com/AndrewWilliam, ©iStock.com/Rawpixel