Depending on income level and eligibility, you can save more annually by doing both than only contributing to your 401(k). In 2015, 401(k) contributions are limited to $18,000 of earned income, plus another $6,000 "catch-up" if you're age 50+. Add the Roth IRA and you have another $5,500 contribution, plus $1,000 "catch-up" if you're age 50+.
While you receive no current income tax deduction for contributions to a Roth IRA or Roth 401(k), those contributions have the potential to grow tax-free over time into retirement (or your death).
Contributing to both pre-tax and post-tax retirement plans may give you options to mix-and-match future retirement plan withdrawals in such a way to minimize the overall tax bite (including the taxability of Social Security).
There are no future Required Minimum Distributions (RMDs) for a Roth IRA, while there are starting at age 70.5 for pre-tax plans such as 401(k) or Traditional IRA.
A primary consideration in the decision is your current income tax bracket vs. anticipated bracket in retirement. If your income is high now and you anticipate it'll be lower in retirement, it generally makes sense to make pre-tax contributions and get the tax deduction now. If your income is lower now vs. what you anticipate in retirement, it may be more beneficial to contribute as much as possible now into post-tax Roth IRA or Roth 401(k). I hope that helps. All the best!
Many people choose to contribute to both a Roth IRA and a 401k for many reasons:
- To maximize the contribution limit: A Roth IRA is limited to $5,500 a year, and a 401k is limited to $18,000 a year. Contribute to both plans may allow you to contribute more.
- Contributing to your company's 401k may allow you to take advantage of the matching contribution from your employer. On the other hand, the investment options can be quite limited. Many people choose to invest in an IRA or Roth IRA to be able to choose the best investment options with lowest costs and fees.
- You can create a mix of pre-tax and after-tax savings. This will give you more flexibility to choose from which account you'd like to withdraw from depending on your tax situation that year.
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