Federal law allows you to diversify your retirement accounts by funding different types of retirement savings plans. You can contribute to traditional and Roth individual retirement accounts (IRAs) up to their respective limits. For example, you can contribute to a traditional tax-deferred 401(k) and to a Roth IRA in the same year.
You can contribute up to $16,500 a year to a tax-deferred, employer-sponsored 401(k) plan, plus an additional $5,500 if you are over age 50. In that same year, you also can contribute up to $5,000 to a tax-free Roth IRA plus an additional $1,000 if you are over age 50. As of the time of publication, there are no income or filing-status restrictions on opening a Roth IRA -- but there are income limits for contributions. You can contribute fully to a Roth IRA only if your income is below $107,000 if you are single, or $169,000 if married filing jointly. You can make a partial Roth IRA contribution if your income is between $107,000 and $122,000 if single and between $169,000 and $179,000 if married filing jointly.
401(k) Plus Roth
Paying into a tax-deferred 401(k) and a separate Roth IRA offers some advantages to middle-income taxpayers. By using both plans separately but simultaneously, you will get a tax deduction each year for your contributions to your 401(k). Although the Roth IRA gives no deduction, it is a hedge against higher future tax rates. Retirement distributions from your 401(k) will be taxed. There’s no guarantee that your tax bracket at retirement will be lower than it is now. It could be higher. Retirement distributions from your Roth IRA are not taxable, so your future tax bracket is irrelevant. At retirement you can split your withdrawals between the taxable 401(k) and tax-free Roth IRA in whatever combination gives you the best tax position.
If you have both a 401(k) plan and a Roth IRA, you should have a strategy for allocating contributions between these accounts. Rande Spiegelman, financial planning vice-president at Charles Schwab, in a September 15, 2010 Schwab website article suggested a strategy that calls for you first to contribute to your 401(k), up to the amount your employer will match. For instance, if you made $60,000 and your employer will match 401(k) contributions up to 5 percent of your salary, you should put $3,000 into your 401(k) to get the $3,000 match from your employer. Then you should contribute to your Roth IRA up to the maximum limit. If you still have more to save, put it in your 401(k) up to the maximum limit to get more of a tax deduction.
If your financial situation doesn’t allow you to max out your contributions to the 401(k) and Roth IRA, Schwab’s Spiegelman suggested you should, if possible, put your available savings money first into your 401(k) to get matching employer contributions. At the opposite extreme, if you still have retirement savings left after maxing out your 401(k) and Roth IRA contributions, you can put the money into secure taxable investments such as stocks, bonds or mutual funds.
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