Both 401(k)s and Roth IRAs are popular tax-advantaged retirement savings accounts. Retirees can opt for either of these accounts as both plans offer attractive tax benefits. In a 401(k), you contribute pre-tax dollars that help reduce your taxable income but your withdrawals will be taxed. In a Roth IRA, you make contributions with your after-tax income and can make tax-free withdrawals in retirement. Both 401(k)s and Roth IRAs offer unique tax benefits to their account holders making them both attractive options for investors.
You can open both a Roth IRA and a 401(k) and benefit from both accounts at the same time. Reach out to a professional financial advisor who can help you understand the various tax benefits, taxability, and contribution limits of 401(k)s and Roth IRAs and guide you on the same.
In this article, we will talk about how you can hold both 401(k) and Roth IRA accounts and reap their benefits at the same time.
What is a 401(k) retirement account?
A 401(k) is a company-sponsored retirement plan wherein employees contribute a portion of their gross income to the account. The contribution is deducted directly from the employee’s paycheck before income taxes have been taken out. Hence, your taxable income is reduced by the total amount of your contributions for the year. You do not have to pay any taxes on your contributions or earnings until you make a withdrawal, usually in retirement. Suppose you earn $65,000 annually and contribute $15,000 per annum to your 401(k) account, you will have to pay income tax on $50,000 and not $65,000. For 2023, the annual limit on employee contributions is $22,500/year. If you are 50 years of age or older, you can make an additional catch-up contribution of $7,500 to your 401(k) account, bringing your total 401(k) contribution to $30,000 per annum.
In a traditional 401(k) account, your employer can match your contributions either partly or fully. Most financial advisors advise that employees should contribute enough funds at a minimum to get the full employer match. This is a good way to boost your retirement savings.
What is a Roth IRA account?
A Roth IRA (Individual Retirement Account) is a tax-advantaged account where you contribute after-tax dollars to earn tax-free growth and returns on your investments. The major tax benefit of a Roth IRA account is that you can make tax-free withdrawals provided you meet the following conditions:
- You must be 59.5 years of age or older
- You must have held your Roth IRA account for at least five years
For 2023, you can contribute a sum of $6,500. However, if you are 50 years of age or older, you can contribute an additional $1,000 to your Roth IRA account. This means that you can contribute a sum of $7,500 in the year. Having a Roth IRA account is beneficial if you expect to be in a higher tax bracket post-retirement.
Moreover, you can withdraw from your Roth account before turning 59.5. However, you need to remember that you can only draw the money contributed by you and not the earnings. If you withdraw your earnings, you may have to pay a 10% penalty on the same.
Additionally, you do not have to take out Required Minimum Distributions (RMDs) in a Roth IRA account, unlike a traditional 401(k). Further, you can pass on your Roth IRA account to your beneficiaries with them not having to pay any taxes on their inheritance. This is not true for 401(k) account holders. The beneficiaries must shell out taxes on any withdrawals made subject to the prevalent income tax slabs and rules.
How can you open both 401(k) and Roth IRA accounts simultaneously?
If you invest in both 401(k) and Roth IRA retirement plans, you can benefit from tax-deferred and tax-free growth at the same time. Doing so would also help maximize your savings rate and build a significant retirement corpus.
Here’s what you need to do:
- First, open a 401(k) account through your employer. If your employer does not offer a 401(k) plan, you can still open one through an online broker. Next, you can open a Roth IRA account with a bank, brokerage company, other financial institutions, or an online broker.
- Though you are allowed to run both kinds of retirement plans, you must keep an eye out on your income to ensure it does not cross the permissible limit for making Roth IRA contributions. For 2023, your Modified Adjusted Gross Income (MAGI) must be less than $153,000 to contribute to your Roth IRA (as a single taxpayer). If you are a married taxpayer filing taxes jointly, your MAGI must be less than $228,000 for the tax year 2023.
What are the benefits of having both 401(k) and Roth IRA accounts?
Let us go through some of the pros of having both 401(k) and Roth IRA accounts:
1. It lowers your taxability
Since employees contribute pre-tax dollars to their 401(k) accounts, it reduces their taxable income. On the other hand, you pay taxes on the contributions made to a Roth IRA account, making your qualified withdrawals tax-free. Thus, you can reduce overall taxability by owning both these retirement accounts.
2. It helps boost your retirement savings
You can boost your retirement savings by maxing out your annual contribution limits along with making catch-up contributions if you are eligible for them. Doing so can help increase your retirement savings significantly and enable you to attain your financial goals sooner.
3. It offers increased flexibility
If you have invested in both 401(k) and Roth IRA plans, you can benefit from increased flexibility when saving for retirement. You do not have to pay taxes while saving for retirement in a 401(k), plus you also benefit from tax-free earnings. Additionally, it is relatively stress-free since contributions are automatically deducted from your paycheck. While you must start taking RMDs in a 401(k) at age 72, you are not required to do so in a Roth IRA. You can let your Roth IRA funds grow tax-free as long as you wish and use them to pay for any emergencies in retirement without attracting a penalty.
4. Employer match benefits
As stated above, if you invest enough funds in your 401(k) plan, your employer will match a certain percentage up to a specific limit. You can boost your savings rate considerably if you take advantage of the 401(k) employer match.
To summarize
If you choose to invest in both 401(k) and Roth IRA retirement accounts, you receive the tax breaks associated with an employer-sponsored retirement plan and an individual retirement account. Doing so will allow you to build a substantial retirement fund and live your golden years comfortably. Take care to stay on top of your contribution limits and when you have to start taking your RMDs and withdrawals to avoid incurring any penalties.
If you want to learn about the taxability, contribution limits, and benefits of having both 401(k) and Roth IRA retirement accounts, use the free advisor match service to connect with 1-3 financial advisors based on your financial requirements. All you need to do is answer a few simple questions about yourself, and the match tool will help connect you to vetted advisors that are best suited to match your financial needs.