Can an Employee Contribute to a Roth IRA & a 401(k)?
Original post by Mark Kennan of Demand Media
If you work at a company offering a 401k plan, you may be able to double dip with your retirement contributions by putting some money in a Roth IRA and some money in a 401k plan. Making sure that you meet the qualifications for both plans and knowing the tax benefits for both plans allows you to judge which combination of retirement plan options best suits your financial situation.
Must Meet Eligibility for Both
The IRS does not prohibit contributions to both a Roth IRA and a 401k plan. However, you must meet both sets of eligibility criteria. For a 401k plan, your employer must offer the plan and you must have compensation to contribute. With a Roth IRA, you must have compensation to contribute and your modified adjusted gross income must fall below the annual limits, which change annually and vary depending on filing status.
Benefits of Diversification
Roth IRAs offer different retirement benefits than 401k plans because of the way the plans are structured. A Roth IRA offers after-tax savings, which means that money you put in does not lower your income taxes for the current year, but does allow you to remove that money without paying taxes at retirement. A 401k plan offers the opposite: Contributions decrease your taxable income for the year, but distributions are taxable. Contributing some money to both plans allows you to hedge your bets and spread your tax liability over both the years you make contributions and the years you take distributions.
Maximizing Your Retirement Savings
Both Roth IRAs and 401k plans have maximum amounts you can contribute each year that you must not exceed or the IRS imposes excess contribution penalties. As of 2011, you can contribute a maximum of $5,000 to your Roth IRA, or $6,000 if your are 50 or older. However, the Roth IRA limit is cumulative with your other IRAs, so any traditional IRA contributions made decreases your Roth IRA contribution limit. With a 401k plan, you can defer up to $16,500 in compensation, or $22,000 if you are 50 or older. Your employer can also contribute money to a 401k plan on your behalf, and the maximum total contribution to your 401k plan cannot exceed $49,000.
Dividing Your Contributions
If you cannot contribute the full annual limit to both your 401k plan and Roth IRA, you must decide how to split the contribution between the two accounts. Because of its after-tax savings, a Roth IRA offers better benefits if you anticipate paying a higher tax rate at retirement. However, if you expect a lower rate, the 401k plan offers the better benefits. In addition, if your employer matches your 401k plan contribution, you essentially turn down free money if you do not contribute the amount needed to maximize your employer's matching contribution.
- Internal Revenue Service: Publication 590
- Internal Revenue Service: Limitation on Elective Deferrals
- Interal Revenue Service: General Distribution Rules; 2011
- Charles Schwab: Saving for Retirement: IRA v. 401k; Rande Spiegelman; 2010
About the Author
Mark Kennan is a freelance writer specializing in finance-related articles. He has worked as a sports editor for "Ring-Tum Phi" and published articles on a number of online outlets. Kennan holds a Bachelor of Arts in history and politics from Washington and Lee University.
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