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William Perez

Maxing out Retirement Savings

By March 15, 2006

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Today's tax question comes from James in California. He asks, "Can you contribute to both a 401(k)/403(b) and a ROTH-IRA?? Which is more advantageous?? Are there any tax consequences in contributing to a 401(k) or 403(b) as opposed to a ROTH-IRA?? The question arose here in my office. Does your website address IRA questions or 401(k) questions??"

Yes, employees can contribute to both a company-sponsored retirement plan, such as a 401k or 403b plan, and contribute to a Roth IRA as well.

Roth IRA Basics
Roth Individual Retirement Accounts are retirement plans set up by individuals. Unlike tax-deductible Traditional IRAs, you cannot take a deduction for funds contributed to a Roth. Instead, funds grow tax-free, and withdrawals will be tax-free too as long as certain requirements are met. For more information on Roth IRAs, see What You Need to Know About Roth IRAs.

Who Can Contribute to a Roth IRA?
You can contribute to a Roth IRA if you have earned income (wages or self-employment) and your "modified" adjusted gross income is under certain limits. Your maximum allowable contribution is based on your income. Your contribution will be limited if your income is within the phaseout range. If your income exceeds the threshold, you cannot contribute to a Roth.

Income Phaseout Ranges

  • Single or Head of Household: $95,000 - $110,000
  • Married Filing Jointly: $150,000 - $160,000
  • Married Filing Separately: $0 - $10,000

Maxing Out Your 401k and Roth Contributions
If your income is under the threshold listed above, you can maximize your retirement savings. For 401(k) and 403(b) plans, you can contribute up to $15,000 for 2006 (or up to $20,000 if you are age 50 or older). For Roth IRAs, you can contribute up to $4,000 for 2006 (or up to $5,000 if you are age 50 or older).

Why Contribute to a Roth When You Already Have a 401k Plan?
There are four good reasons why you might want to save for retirement in a Roth IRA in addition to a 401(k) or 403(b) plan.

First, you may have already maxed out your 401k, and want to save more. If you are covered by a retirement plan at work, you will not be able to contribute the maximum to a tax deductible Traditional IRA. So the Roth IRA may be your only option for setting aside extra retirement savings.

Second, you may want to invest in mutual funds, stocks, bonds, or certificates of deposit that are not available through your company's retirement plan. With a Roth IRA you are in full control of selecting your investments.

Third, Roth IRAs do not have many of the restrictions that Traditional IRAs have. You cannot add more funds to a Traditional IRA and you must begin making withdrawals when you reach age 70 and a half. With a Roth, however, you can continue to add funds at any time (as long as you have earned income), and there's no required minimum distributions. This means you can plan out your retirement income by withdrawing money first from a 401k plan, and then tapping into a tax-free Roth IRA as needed.

Fourth, tax rates might be higher in retirement than they are now. While no one can predict the future, it makes sense to put some savings into tax-free Roth IRAs as a way to protect some of your investments from higher tax rates.

Here's a bonus retirement planning tip: Contribute just enough funds to a 401k so that you get the most matching funds from your employer. Then, compare your investment options between your 401k plan and your investment options with a Roth IRA. If the investments in your 401k plan make sense for you, contribute more to your 401k, up to the maximum allowed. If the investments in your 401k plan don't make a whole lot of sense, or if there are other investments that you prefer, then put the rest of your retirement savings into a Roth IRA.

Bottom Line
Overall, contributing the maximum to both retirement plans provides the best of both worlds. You reduce your taxable wages and income taxes through your 401(k) or 403(b) plan. Plus you are saving money for retirement in a tax-free Roth. This is a one-two punch that can kick your retirement savings into high gear, and provide you with the most flexibility to plan out your withdrawals in retirement.

More Information:

Links to Essential Tax Information from the IRS:

Throughout the tax season I will be answering one tax question per day. Do you have a question? Visit the Ask a Tax Question page. Disagree with my answers? Post your comments in the Tax Forum.

Comments
November 29, 2008 at 3:48 pm
(1) Ken says:

Is this information correct..? From above..I thought that anyone can contribute to an IRA.

Who Can Contribute to a Roth IRA?
You can contribute to a Roth IRA if you have earned income (wages or self-employment) and your “modified” adjusted gross income is under certain limits. Your maximum allowable contribution is based on your income. Your contribution will be limited if your income is within the phaseout range. If your income exceeds the threshold, you cannot contribute to a Roth.

December 17, 2008 at 4:35 pm
(2) taxes says:

Not every one is eligible to contribute to a Roth. Eligibility depends on a person’s modified adjusted gross income.

July 6, 2012 at 11:03 am
(3) Bonita Springs Bookkeeping says:

Usually I do not read post on blogs, but I wish to say that this write-up very pressured me to take a look at and do it! Your writing taste has been surprised me. Thank you, very great article.

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