Saving in Both a 401(k) and a Roth IRA—Is It a Good Idea?

Why It Makes Sense to Save in Both a 401(k) and a Roth IRA

A simple retirement saving formula.
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Investing in a 401(k) plus a Roth IRA offers the perfect combination of tax savings—some now and some in the future. Roth IRA contributions are made with after-tax dollars, so there's no conflict between this type of plan and a 401(k). There are some contribution and deduction limits, but you're permitted to contribute to both if you qualify.

Pretax vs. After-Tax Dollars

A Roth IRA is a great choice if you're already making regular contributions to a 401(k) and you're looking for a way to save even more retirement dollars. 401(k) contributions are made with pretax dollars, whereas Roth IRA assets involve saving your after-tax dollars.

Eventually, the money that represents your contributions to a 401(k) will be taxed at the time you take it out because you haven't yet paid taxes on that money. Roth distributions of principal will not be taxed because you've already paid taxes on your contributions. The investment growth in both these accounts is tax-deferred until retirement.

Taxes on Roth Withdrawals

Roth IRA contributions can also be withdrawn at any time without any taxes or penalties, but you might have to pay taxes and penalties on the withdrawal of the earnings.

The flexibility of being able to access your original contributions without paying taxes or penalties makes a Roth IRA a great savings vehicle for other goals, like a buying a house or paying for a child's college education. And while 401(k) and traditional IRA investors are required to begin taking distributions from those accounts at age 70 1/2, there are no required minimum distributions from a Roth account until after the owner's death. 

Who Is Eligible? 

Your human resources administrator can help you determine your eligibility if you work for a company that offers a 401(k). The Internal Revenue Code limits 401(k) contributions to no more than $19,000 a year in 2019, up from $18,500 in 2018, or $20,000 if you're 50 or older.

Your modified adjusted gross income (MAGI) must be $137,000 or less as of 2019 for you to be eligible to contribute to a Roth IRA. This limit applies if your filing status is single or head of household. It increases to $203,000 if you married filing jointly or a qualifying widow(er). The cap for those who are married and filing separate returns is $10,000.

Other Retirement Account Combinations

If you don't have a 401(k) through work, you can contribute to both a traditional IRA and a Roth IRA as long as your combined contributions don't exceed the $6,000 annual limit as of 2019. Again, this increases to $7,000 for those who are age 50 or older.

It might not make sense to contribute to a traditional IRA and 401(k) in the same year unless you're eligible for deductible contributions because these two accounts are designed to do exactly the same thing. The only difference is that IRAs have much lower contribution limits than 401(k)s.

You can contribute to a small business retirement plan, such as a SEP IRA, if you earn income from freelance or contracting work on the side.

About IRA Deductions

Investors who have 401(k)s don't automatically get an upfront tax deduction the way traditional IRA investors do, but you can qualify for a full deduction if your MAGI is less than $64,000 as of 2019. You must be single or file as head of household. 

The deduction amount begins phasing out with MAGIs of between $64,000 and $74,000. You cannot claim the IRA deduction at all if your income is over $74,000.

Deductions begin to phase out at $103,000 and are capped at $123,000 for married couples who file joint tax returns if the spouse who is making the contribution is covered by a 401(k) or related plan at work. This increases to $193,000 to $203,000 if the contributing spouse is married to someone who's covered by a workplace plan. The phase-out range for a married individual filing a separate return is $0 to $10,000.

SEP contributions are fully deductible up to 25 percent of gross annual income of $56,000 in 2019, even if you max out your 401(k) contributions. This can really put a dent in your tax bill. 

How Much to Contribute to a 401(k) and a Roth IRA

It's usually advisable from a financial planning perspective to take full advantage of any employer matching contributions to a retirement plan at work before considering an IRA. It makes sense to contribute at least as much as the matching percentage if your employer matches 401(k) contributions.

Ten to 15 percent of pretax income is a good rule of thumb for serious retirement investors. After that, consider maxing out a Roth IRA, or at least set 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. 

NOTE: The content on this site is provided for informational purposes only. It's not intended to be professional financial advice and should not be the sole basis for your investment or tax-planning decisions.