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You can have both a 401(k) and a Roth IRA at the same time. Contributing to both is not only allowed but can be an effective savings strategy for retirement. There are, however, some income and contribution limits that determine your eligibility to contribute to both types of accounts.
Assuming you meet the eligibility requirements, contributing to both a 401(k) and Roth IRA can provide tax advantages in both the near and long term. Whether you've already started saving for retirement or plan to start soon, knowing how these accounts can work together to build your retirement nest egg can be helpful. Here's what you need to know.
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Benefits of Contributing to Both a 401(k) and Roth IRA
Contributing to both a 401(k) and Roth IRA allows you to maximize your retirement savings and benefit from tax advantages. With a 401(k) account, you'll contribute money you haven't yet paid taxes on. Your employer may also match contributions up to a certain percentage of your annual income.
With your Roth IRA, contributions are made after you've paid taxes, but qualified distributions, or withdrawals, are not taxed. Additionally, contributing to these accounts may make you eligible for a tax credit known as the Saver's Credit, which could be up to 50% of your contributions. When you combine these accounts, you can stack your tax benefits while saving for retirement.
How a 401(k) Works
The contributions that you make to your 401(k) are excluded from your taxable income, which is why this is called a tax-deferred account. So if you earn $40,000 annually and contribute $3,000 to your 401(k) for the year, the IRS will consider your taxable income to be $37,000 (not counting any other income-reducing factors). In some cases, reducing your taxable income could mean less of your income is in a higher tax bracket and save you even more money come tax season.
For the 2022 tax year, you can contribute up to $20,500 to your 401(k) account. If you are 50 years old or older, some 401(k) plans will let you add "catch-up contributions" of up to $6,500, allowing for a total of $27,000 in contributions for 2022. Each year, these contribution limits change, so be sure to check the latest IRS publications for updates.
When you invest through your 401(k) account, your earnings grow tax-free. But once you start withdrawing your 401(k) account balance, at age 59½ or later, the distributions are taxed as ordinary income. This has benefits if your income is lower in retirement, since you should expect to get taxed at a lower rate. Withdrawing money from your 401(k) before you're 59½ years old results in a 20% tax withholding and carries an additional 10% penalty, so it is not advisable.
How a Roth IRA Works
A Roth IRA is a tax-advantaged account funded with contributions made with money that's already been taxed. Qualified withdrawals are tax- and penalty-free. Distributions are not taxable as long as you've had the account for at least five years and are at least 59½ years of age. There are some other circumstances that allow you to withdraw funds from this account without penalties as well. You can use the IRS Interactive Tax Assistant tool to see if your Roth IRA withdrawal is qualified and exempt from taxes.
Like a 401(k), there are annual limits to how much you can contribute to your Roth IRA each year. You can contribute up to $6,000 ($7,000 if you're 50 years old or older) for 2022 as long as your modified adjusted gross income doesn't exceed these limits:
- Married filing jointly: $204,000
- Single, head of household or married filing separately: $129,000
Other benefits of a Roth IRA include being able to withdraw contributions (not earnings) without penalty and not being subject to required minimum distributions like other retirement accounts. Since there's no requirement to withdraw funds at a certain age, this type of account can also be used as an estate planning tool to transfer wealth to heirs after your death.
Note, some employers may also offer a 401(k) Roth plan, also known as a Designated Roth 401(k), which combines features of both a 401(k) and a Roth IRA. The contribution limits are the same as a 401(k), but they are made with money that's already been taxed. This 401(k) Roth account type is distinct from the Roth IRA contributions your employer may facilitate or a Roth IRA you might open with a brokerage on your own.
How to Invest With Both Account Types
If you want to make contributions to both a 401(k) and a Roth IRA account, you need to first make sure you can contribute to both based on availability and income eligibility. For the 401(k) account, there's no income limit, but there is a limit on how much you can contribute annually. If you've got a unique situation with more than one employer or a solo 401(k), you must ensure that you don't go over the contribution limits for the year—especially if you are contributing to multiple 401(k) accounts within the year. If your employer matches 401(k) contributions, it's typically wise to take full advantage of that before contributing to a Roth IRA.
For a Roth IRA account, you should make sure that you will not exceed the income thresholds the IRS sets for this account. If you're able, you can add contributions to your Roth IRA in one of two ways:
- Contribute through your employer. If your employer facilitates IRA contributions as part of an employer-sponsored retirement savings plan, you can designate a portion of your paycheck to go to either a Roth IRA or a traditional IRA. Once the funds are in the account, your plan administrator will invest them according to the preferences you established with them.
- Contribute through a bank, credit union or investment brokerage. Most, if not all, of these financial institutions allow you to open a Roth IRA account online. Once it's open, you may add funds, then invest them as you see fit. You also have the option to open a traditional IRA if you'd like to make pretax contributions.
The Bottom Line
There are many ways to reach your retirement goals. Combining a 401(k) and a Roth IRA can help you realize tax and estate planning benefits at different points along your financial journey. If you need more guidance when it comes to saving for retirement, consider working with a financial planner or other experienced financial professional.