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 both a 401(k) plan and 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), which is funded with pre-tax dollars. There are some contribution and deduction limits, but the IRS permits you to contribute to both.

Tax and Distribution Considerations

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. 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 those contributions. The investment growth in both these accounts is tax-deferred until retirement.

Because the value of your Roth IRA contributions can be withdrawn at any time without any taxes or penalties, a Roth IRA a great savings vehicle for other goals, like buying a house or paying for a child's college education.

One more significant difference between a 401(k) and a Roth IRA is that investors in a 401(k) or a traditional (non-Roth) IRA are required to begin taking distributions from those accounts at age 70.5, while there are no required minimum distributions from a Roth IRA account until after the owner's death.

Eligibility and Contribution Limits

There are no modified adjusted gross income (MAGI) limits for contributing to a 401(k), so you can make use of this retirement account no matter how much or how little money you make. If you earn above a certain amount of MAGI, you may not be able to contribute to a Roth IRA the full amount legally allowed each year or you may not be able to contribute at all. The amount of your contribution also depends on your income tax filing status.

If Your Filing Status Is ... ... and Your MAGI Is ... ... Then You Can Contribute ...
Married filing jointly or qualified widow or widower < $196,000 up to the limit
Married filing jointly or qualified widow or widower ≥ $196,000 but
< $206,000
a reduced amount
Married filing jointly or qualified widow or widower ≥ $206,000 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 < $124,000 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 ≥ $124,000 but
< $139,000
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 ≥ $139,000 zero

Source: IRS

The amounts in the chart are the totals you may contribute to all IRA accounts—both traditional and Roth—in 2020.

The usual limit for 2020 is $6,000. If you're 50 or older, it's $7,000. Those amounts are unchanged from 2019.

To calculate the amount of your permitted reduced contribution, first subtract from your MAGI one of three amounts:

1) $196,000 if you're married and filing a joint return or are a qualifying widow or widower

2) zero if you're married and filing a separate return and you lived with your spouse at any time during the year

3) $124,000 if you have any other filing status

If you're 49 or younger, you can contribute $19,500 to your 401(k) in 2020. That's up from $19,000 in 2019. If you're 50 or older, you can contribute an additional $6,500 in 2020. That's $500 more than in 2019.

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 or $7,000 annual limit.

It might not make sense to contribute to a traditional IRA and 401(k) in the same year because those two kinds of 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.

How Much to Contribute

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

A good rule of thumb for serious retirement investors is 10% to 15% of pretax income. After that, consider maxing out a Roth IRA 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.

The Balance does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.

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