Putting your money into both a 401(k) plan and a Roth IRA offers the perfect mix of tax savings—some now and some in the future. Roth IRA savings are made with after-tax dollars, so there's no conflict between this type of plan and a 401(k), which is funded with pre-tax dollars.
There are some contribution and deduction limits, but the IRS permits you to save money to both.
Tax and Distribution Factors
A Roth IRA is a great choice if you're already saving regularly to a 401(k) and you're looking for a way to save even more. The money in your 401(k) will be taxed at the time you take it out because you didn't pay taxes on your contributions. Roth distributions of principal will not be taxed because you've already paid taxes on this money.
The growth in a 401(k) is tax-deferred until you take it out in retirement. Roth IRA earnings aren't taxable in most cases if you've held the account for at least five years.
A Roth IRA can be a great savings option for other goals, like buying a house or paying for a child's college costs. The value of your Roth contributions can be withdrawn at any time without any taxes or penalties because you've already paid taxes on this money at the time you earned it.
You must begin required minimum distributions (RMDs) from a 401(k) or a traditional (non-Roth) IRA at age 70½, but there are no required minimum distributions from a Roth IRA account until after the owner's death. The account's beneficiaries may be required to take RMDs in order to avoid penalties.
Eligibility and Contribution Limits
There are no modified adjusted gross income (MAGI) limits for saving to a 401(k), so you can make use of this type of account no matter how much or how little money you earn. You may not be able to save the full amount allowed each year to a Roth IRA, or you may not be able to contribute at all, if you earn above certain MAGI limits.
The amount of your contribution also depends on your income tax filing status.
|2021 IRA Income Limits|
|If Your Filing Status Is:||And Your MAGI Is:||Then You Can Contribute:|
|Married filing jointly or qualified widow or widower||< $198,000||Up to the limit|
|Married filing jointly or qualified widow or widower||≥ $198,000 but < $208,000||A reduced amount|
|Married filing jointly or qualified widow or widower||≥ $208,000||Zero|
|Married filing separately and you lived with your spouse at any time during the year||< $10,000||A reduced amount|
|Married filing separately and you lived with your spouse at any time during the year||≥ $10,000||Zero|
|Single, head of household, or married filing separately and you didn't live with your spouse at any time during the year||< $125,000||Up to the limit|
|Single, head of household, or married filing separately and you didn't live with your spouse at any time during the year||≥ $125,000 but < $140,000||A reduced amount|
|Single, head of household, or married filing separately and you didn't live with your spouse at any time during the year||≥ $140,000||Zero|
The amounts you can save applies collectively to all IRA accounts—both traditional and Roth—in 2021. It's not a limit for each account.
The IRA contribution limit for 2021 is $6,000. If you're 50 or older, it's $7,000. Subtract from your MAGI one of three amounts to figure out the amount of your permitted reduced contribution:
- $198,000 if you're married and filing a joint return or are a qualifying widow or widower
- $0 if you're married and filing a separate return and you lived with your spouse at any time during the year
- $125,000 if you have any other filing status
You can save $19,500 in your 401(k) in 2021 if you're age 49 or younger. You can save an extra $6,500 if you're age 50 or older.
Other Retirement Account Combos
You can save to both a traditional IRA and a Roth IRA if you don't have a 401(k) through work, as long as your combined savings don't exceed the $6,000 or $7,000 annual limit.
It might not make sense to save to a traditional IRA and 401(k) in the same year because these two kinds of accounts are designed to do the same thing. The only difference is that IRAs have much lower contribution limits than 401(k)s.
You can save to a small business retirement plan, such as a SEP IRA, if you earn income from freelance or contracting work.
How Much to Save
It makes sense to take full advantage of any employer matching contributions to a plan at work before putting money into an IRA. Save at least as much as the matching percentage if your employer matches your 401(k) contributions.
A good rule of thumb is to save 10% to 15% of pretax income. Consider maxing out a Roth IRA after you reach this point, or at least setting aside as much as you can into this type of account throughout the year. The tax benefits will pay off, particularly if you expect your income tax rate to rise over time.
Frequently Asked Questions (FAQs)
What's the difference between a Roth IRA and a 401(k)?
An IRA and 401(k) are both retirement savings vehicles. An IRA is an account opened by individuals, and a Roth IRA allows you to save after-tax funds to withdraw tax free in retirement. Whether you can contribute to a Roth IRA depends on your income. A 401(k) is sponsored by an employer. You contribute pre-tax funds to a 401(k), and an employer may contribute as well. Those contributions lower your income taxes.
What's the difference between a Roth IRA and a traditional IRA?
Both types of IRAs allow you to save for retirement. A Roth IRA allows you to save after-tax funds, and you must meet income requirements to continue to one. You can withdraw those funds tax-free in retirement. A traditional IRA allows you to save pre-tax funds, and you may be able to deduct your contributions depending on your income and whether you and/or your spouse have retirement plans at work. You pay taxes on withdrawals in retirements.