Saving up for retirement is important if you want to have financial freedom in your later years. That’s why it’s good to find an investment plan that works for you. However, you may be wondering if can you have a Roth IRA and a 401k. The simple answer is yes.
While you can have a Roth IRA and a 401k, you need to understand the differences between the two and the contribution limits that each plan has. Both retirement accounts have their pros and cons when it comes to making the most of your retirement savings. When contemplating if you should contribute to a 401k and a Roth IRA, you need to understand what they are.
What Is a Roth IRA?
A Roth IRA is an individual retirement account that is set up by you at an investment firm. You have full control over how you want to invest your money. Your choices aren’t as limited as they may be with a 401k. This type of investment account has nothing to do with your employer, so you don’t have to worry about limitations on that end.
Roth IRAs accept funds after tax for your contributions. This means that withdrawals can be made tax-free in your retirement, as long as you follow all of the applicable rules for avoiding penalties.
What Is a 401k?
A 401k is a retirement plan sponsored by employers. Contributions to your 401k retirement savings are made by designating a part of your paycheck toward your retirement plan. This means that your contributions are made pre-tax. There are many investment options for a 401k, but they may be more limited because of your plan administrator.
You might find that a 401k retirement savings plan is most advantageous to you if your employer matches your contribution. This means that your employer contributes additional money to your account. Usually, this is a percentage of your contribution, but no more than a predetermined percentage of your salary.
What are the Differences between a Roth IRA and a 401k?
For retirement, you should take advantage of a 401k and a Roth IRA. In a perfect world, you should be able to contribute to a Roth IRA and 401k plan so you can have a secure retirement plan with financial freedom.
A 401k retirement plan has much larger contribution limits than a Roth IRA. These annual contribution limits change every year and vary based on marital status, earned income, and other factors. For a Roth IRA, your ability to contribute is determined based on your income.
Eligibility differs for these two types of retirement plans. Anyone who has earned income can contribute to a Roth IRA. On the other hand, a 401k is limited to employees, because it is an employer-sponsored retirement savings plan.
Roth IRA contributions are made with after-tax dollars. That’s unlike a 401k, which is funded pre-tax. Since a 401k reduces your taxable income, it can actually save you money.
Investment options vary based on what your plan administrator for your 401k selects. Generally, they tend to be more limited than a Roth IRA. Since a Roth IRA is an individual plan, it allows you to have complete control of your investment choices and options.
A 401k plan offers tax-deductible contributions, but you will have to pay taxes on withdrawals. This is not the case for a Roth IRA, as you can avoid taxes and penalties through certain conditions. Examples include:
- Having an account over 5 years old
- Making a withdrawal after you are 59 ½ years old, as the IRS explains
- Using a withdrawal to buy or build your first home (as long as it is $10,000 or less)
Required Minimum Distributions (RMDs)
Roth IRAs have no RMDs. If you don’t need your money during retirement, then you can leave it for your beneficiaries. This can be a good option for those that want to plan ahead and leave something behind for family members.
A 401k does have RMDs. If you don’t take them, you may face penalties.
Start Preparing for Retirement
You can have both a Roth IRA and a 401k account can be beneficial to your retirement savings plan, but you need expert advice to decide on whether or not you can or should contribute to both. Each investment option has its tax benefits. Are you still wondering if you can contribute to a Roth IRA and a 401k?
Call the Pros at Asset Preservation & Wealth
Stewart Willis is the founder and president of Asset Preservation Wealth & Tax, a financial planning firm in Phoenix, Arizona. Investment advisory services offered through Foundations Investment Advisors, LLC, an SEC registered investment adviser.
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