The 401(k)/Roth IRA Combo Platter: How It Can Work to Your Advantage (2024)

FAQs

What is the benefit of having a Roth IRA and 401k? ›

“Future tax rates are heading higher, possibly much higher, so maxing out both a Roth IRA and a 401(k) will give you more net after-tax dollars in retirement.” If your employer offers a 401(k) plan, you can choose to contribute to either a traditional 401(k) account or a Roth 401(k) account (or both).

A Roth 401(k) is an employer-sponsored after tax retirement account that has features of both a Roth IRA and a 401(k). Like a Roth IRA, contributions to a Roth 401(k) are made with income that's already been taxed, allowing investments to grow and be withdrawn in retirement without being taxed.

Two popular examples are individual retirement accounts (IRAs) and workplace-sponsored 401(k) plans. Both let you choose from a menu of investments, offer tax breaks either when you contribute or withdraw money, and let your account grow tax deferred in the meantime.

If you're age 59½ or older and have owned your account for at least 5 years,* you can withdraw money—contributions plus earnings—from your Roth IRA without paying any penalties or taxes. So even if you take a lump-sum withdrawal in retirement, your retirement income won't be affected.

Bottom line. The best way to maximize your retirement savings is to diversify how you grow that nest egg. Adding a Roth IRA along with your employer-sponsored traditional 401(k) gives you the opportunity to take advantage of different tax benefits, withdrawal rules and contribution limits.

The Bottom Line. In many cases, a Roth IRA can be a better choice than a 401(k) retirement plan, as it offers more investment options and greater tax benefits.

No tax deferral now. The list of cons may be short for Roth 401(k)s, but missing tax deferral is a big one. When faced with a choice of paying more tax now or later, most people choose to pay later, hence the low participation rates for Roth 401(k)s.

Once you've owned the Roth 401(k) for at least five years and are at least 59 ½ years old, you can withdraw both contributions and earnings without penalty or tax. Just be careful here because the five-year rule supersedes the age 59 ½ rule.

With Roth IRA, you pay your usual tax and then fund your account. So you'll pay slightly more tax throughout your life, but after you retire all the gains are yours! The allowances and limits for both these types are the same, and you can even have both if you decide to do so.

Once you reach 59½, you can take distributions from your 401(k) plan without being subject to the 10% penalty. However, that doesn't mean there are no consequences. All withdrawals from your 401(k), even those taken after age 59½, are subject to ordinary income taxes.

What happens to my 401k when I quit? ›

If your 401(k) has less than $1,000 when you quit a job, the IRS allows the plan administrator to automatically withdraw your money and send you a check, minus 20% in taxes, per the IRS. You can also initiate a rollover: a direct transfer of your money from a 401(k) account to another tax-advantaged retirement account.

Roth individual retirement accounts (IRAs) offer several key benefits, including tax-free growth, tax-free withdrawals in retirement, and no required minimum distributions (RMDs). One key disadvantage: Roth IRA contributions are made with after-tax money, meaning there's no tax deduction in the years you contribute.

If you contribute 5,000 dollars per year to a Roth IRA and earn an average annual return of 10 percent, your account balance will be worth a figure in the region of 250,000 dollars after 20 years.

Let's say you open a Roth IRA and contribute the maximum amount each year. If the base contribution limit remains at $7,000 per year, you'd amass over $100,000 (assuming a 8.77% annual growth rate) after 10 years. After 30 years, you would accumulate over $900,000.

Covering your bases through tax diversification

If you're not sure where your tax rate, income, and spending will be in retirement, one strategy might be to contribute to both a Roth 401(k) and a traditional 401(k).

Key Points. You can fund an IRA if you have a 401(k) plan through your employer. Having a workplace retirement account could make you ineligible to deduct traditional IRA contributions. Funding a 401(k) could help you reduce your taxable income so that you can directly fund a Roth IRA.

The contribution limits are the same for Roth and traditional versions of 401(k)s and IRAs. One financial strategy, for those who want to maximize their tax-advantaged savings: Open both types of Roth accounts. You can invest up to the combined allowable limits in a Roth 401(k) and a Roth IRA.

Once you're set up to get the full match in your 401(k), next consider contributing to an IRA. If you're eligible for the tax deduction, a traditional IRA can offer a lot of benefits beyond that tax break, including access to low-cost investments and low or no administrative fees. A Roth IRA is another option.