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How to Max Out Your Roth IRA

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone and is not intended to be a source of investment advice. It may not have not been reviewed, commissioned or otherwise endorsed by any of our network partners or the Investment company.

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It might feel like a far-away goal to max out your Roth IRA if you have one. Since Roth IRAs are taxed when you make contributions and not when you take money out, it may seem like you’re putting even less money in at first deposit.

But that doesn’t mean you shouldn’t fill up your Roth IRA every chance you get. Remember when you take money out later in life, it’s all yours — the IRS already took its share.

Should I max out my Roth IRA every year?

Yes, of course. But the caveat is: only if you can.

If you have a work-sponsored 401(k) and your employer matches, this should be your priority. Take advantage of this generous match for as long as possible. All your independent retirement investment accounts should come after this.

Once you’ve contributed enough to get your employer’s full match, craft your budget to include the most you can put into your Roth IRA. It’s always a good idea to contribute the most you can. The more you save early on in your career, the more you’ll have in retirement from letting it build over time.

Compound interest — or interest building on top of interest — can increase your retirement savings much more than if you were to start saving later in life. If one day you lose your job or you can’t work anymore, using the time you had now to save every chance you get will be helpful.

How to max out your Roth IRA

1. Open an account

If you don’t have a Roth IRA, now is the time to get one. But first, you need to make sure you’re eligible.

Roth IRAs have eligibility requirements based on your income. If you file your taxes as a single or head of household, you can’t contribute to a Roth if you earn more than $140,000 per year. For the 2021 tax year, if you earn between $125,000 and $140,000 you can contribute, but not the full amount. If you’re married and file jointly, you need an income of less than $208,000 to be eligible.

If you earn too much, you might want to look into other retirement investment options, like a Traditional IRA. These don’t have income requirements like Roth IRAs do and you can max out contributions without worry.

If you have to open a Traditional IRA now, don’t worry. You can still roll over to a Roth IRA later. This is sometimes called a “backdoor IRA,” where you start with a Traditional IRA and then move to a Roth IRA.

2. Understand contribution limits for 2021

The maximum amount you can contribute changes often. The limit for the tax year 2021 is $6,000, or $7,000 if you’re 50 or over. While it’s great to max out your Roth IRA, that might be high if you don’t have a lot of wiggle room after your other financial obligations. Consider contributing what your budget allows.

Don’t forget about last year, too. If you didn’t contribute to a Roth or max out your contributions last year, you have until April 15 to make contributions for the previous tax year.

3. Never skip a contribution window

You don’t get a lot of chances to make something up. To max out your Roth IRA, you get a full year plus the first four months of the next year to contribute as much as you’re allowed to. But after that, you’re out of luck: once the window closes for the year, it doesn’t open again.

That means you can’t wait to make contributions because you think you have time. Time will run out before you know it.

4. Set up a contribution plan

Because of your limited open window, you’ll need to stay diligent about making contributions. If your Roth IRA allows it, set up auto-deductions to make deposits every month. If you don’t have it available, add calendar reminders to let you know when it’s time to pay into your Roth IRA.

If you can’t set up monthly payments, you can look into making a few big payments or one lump sum. If you plan on getting a hefty tax refund, you might consider using it to max out your Roth IRA.

Are you trying to max out your Roth IRA?

Don’t be discouraged if you can’t max out your Roth IRA this year. It’s not always feasible, given different financial limitations. Maybe you have a large mortgage payment or you got a new car. Or you got laid off and you’re trying to make ends meet. Whatever your situation is, it’s OK to take care of your obligations before your retirement plan. On the other hand, if you can max out your Roth IRA and have more money to invest, consider aiming to also max out your 401k.

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401(k) Alternatives to Consider

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone and is not intended to be a source of investment advice. It may not have not been reviewed, commissioned or otherwise endorsed by any of our network partners or the Investment company.

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Investing in a work-sponsored 401(k) account is one of the easiest ways to save for retirement. But if your work doesn’t offer one or it isn’t that great, there are 401(k) alternatives you can turn to for your investment needs.

Why you should consider 401(k) alternatives

Having a 401(k) through your job is a simple step to investing in your retirement without much work, but there are some downsides of having one.

Employer-sponsored plans handle a lot of the labor for you, which is one major benefit to having one. However, you may still be responsible for any fees associated with having a retirement plan through your work. It’s possible you’ll never notice these fees either, as it’s not a line-item on your paycheck and is taken directly from your investment funds.

A TD Ameritrade survey found that about one in four Americans know how much they’re paying in 401(k) fees compared to 96% of Americans that know how much their streaming services cost (such as Netflix and Hulu). 401(k) fees can cost upwards of 5%, while Robo-advisors — like Betterment — only charge an annual fee of 0.25%.

Depending on your employer and specific plan, you may run into some other issues such as limited investment options and restricted flexibility compared to a retirement plan you handle on your own.

401(k) alternatives

While you should take advantage of an employer-sponsored 401(k) plan if it’s available, it doesn’t need to be the only plan you have. Here are some other options worth considering:

Roth IRA

A Roth IRA is an individual retirement account that allows you to contribute up to $6,000 a year. Withdrawals are tax-deductible and you can make taxable contributions for as long as you’d like with no age limitations.

For Roth IRAs, there is an income requirement to meet. For the 2021 tax year, you’ll need to make less than $140,000 as a single filer or less than $208,000 if filing jointly to participate.

Traditional IRA

A Traditional IRA is also an individual retirement account that allows you can contribute up to $6,000 each year. Taxes work opposite of a Roth, and instead of tax-deductible withdrawals, your contributions are taxed. This means all the money you put into a Traditional IRA is tax-free.

Traditional IRAs have a deadline that prevents you from making contributions — and requires minimum distributions — by 70 and a half years old. Your contributions are taxed once you start taking money out.

SEP IRA

A SEP IRA, or Simplified Employee Pension, is an individual retirement account for sole proprietors or business owners with one or more employees. This plan allowed you to save up to 25% of your gross annual salary if you’re self-employed.

SEP IRAs are like traditional 401(k) plans — your contributions aren’t taxed but your withdrawals are. Like a traditional IRA, you’re required to make withdrawals starting at 70 and a half years of age.

Solo 401(k)

A Solo 401(k) is a lot like a SEP IRA in that it’s made for self-employed workers who don’t otherwise have a 401(k) option through their workplace.

For a Solo 401(k), a portion of your income is deferred so it can grow tax-free until retirement. Like a traditional 401(k) plan, you can contribute up to $19,500 of your earned income (plus an extra $6,500 if you’re 50 years of age or older).

Health Savings Account

A Health Savings Account (HSA) is like a personal savings account that can only be used for healthcare-related expenses. You must have a High-Deductible Health Plan (HDHP) to qualify for an HSA.

A major draw of HSAs is its tax-free triple threat. You can contribute and withdraw without tax obligations while your earnings grow tax-free. For the 2021 tax year, you can contribute up to $3,600 for yourself or $7,200 for your family.

Even with an HSA and lower monthly premiums, you may not be able to afford the high deductible on your health plan. If you have an emergency or an unexpected cost and not enough in your HSA to cover the balance, you’ll need to pay for those expenses out of pocket.

Taking money out of your HSA for non-healthcare costs is expensive, too. Your withdrawals will be taxed and you’ll have to pay a 20% penalty. If you’re over 65 years of age, only your withdrawals will be taxed, but you won’t face a penalty.

Annuities

Annuities, sold by insurance companies, is a form of investment that will pay-out to the investor through a series of recurring payments. The investor pays a lump sum of money to the insurer who then invests your money.

For immediate annuities, also known as income annuities, you’ll start receiving money right away. This may be appropriate for those that are close to retirement as there isn’t a lot of time to build your investment. Deferred annuities start payouts later, which gives your money more time to grow. There are no contribution limits to deferred annuities.

Long-term care annuities are a form of deferred annuities, but with a little extra security. This may be a good option for those with pre-existing conditions or other health issues. Those in good health may want to look at alternatives, such as life insurance with a long-term rider. Be mindful that you’ll need to pay a large sum of money to open an annuity regardless of the type of annuity you choose.

Taxable investment account

While IRAs focus on tax-free contributions and withdrawals, taxable investment accounts tax on money earned in a given year.

Unlike IRAs, you can withdraw money from a taxable investment account at any time instead of hitting a certain age (usually 59 and a half). You also aren’t required to take RMDs when you reach the age of 70 and a half, either.

You can open taxable investment accounts through robo-advisors or traditional brokerages. Robo-advisors allow you to be more hands-off with your investments and do most of the leg-work work for you. Online brokers allow you to have more control over your investments.

If you don’t have a lot of cash to start investing, you can look into micro-investing. While some robo-advisors and online brokers have account minimums, micro-investing gives you the chance to invest your spare change.

Another low-cost alternative to a 401(k) is investing in index funds. These are like mutual funds and are “passive” income earners. That means they’re not “actively” managed by a human, which is how most robo-advisors work to keep fees and costs low.

Bottom line

There are a lot of options available for an alternative 401(k) solution. How you decide to invest your money is entirely dependent on how much money you have to invest, the type of investor you are and the options available through your current employer — if you have one.

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What Happens If You Overcontribute to Your 401(k)?

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone and is not intended to be a source of investment advice. It may not have not been reviewed, commissioned or otherwise endorsed by any of our network partners or the Investment company.

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Maxing out your 401(k) contributions is a good thing. It means you’re taking full advantage of an employer-sponsored retirement account to help set yourself up for worry-free golden years.

But is it possible to over-contribute to your 401(k)? Yes, and there are real consequences to doing so.

Why you might over-contribute to your 401(k)

For the 2021 tax year, 401(k) contribution limits are up to $19,500. This is great compared to an Individual Retirement Account (IRA), which limit contributions to $6,000. (Those over the age of 50 may be able to contribute more than that, however.)

While hitting the maximum amount is a good thing, there are a few instances where you might find yourself going over the 401(k) contribution limit.

You switched jobs

If you left a job with a retirement plan and your new company also has a retirement plan, you might have two separate 401(k) accounts. It’s possible to start a new job and leave your old 401(k) plan behind.

This gives you the chance to max out your 401(k) at your new job, forgetting that you already made contributions to your old 401(k).

You have lots of jobs

If you have many jobs — with many different retirement accounts — it’s possible to lose track of how much money is where. While holding down many full-time jobs is hard, some companies offer retirement plans to part-time and contract workers.

If you have a few different jobs that offer this benefit, you might not be able to keep up with all your plans. It’s possible that you may over-contribute if you don’t keep track of each of them carefully.

Your raise or bonus pushed your contributions over the limit

Setting up automatic contributions to your employer-sponsored 401(k) is a great way to make sure you’ll max out your 401(k) without putting in a lot of effort. But you could go over if you get a pay bump or bonus.

When you get a bonus, any traditional deductions such as taxes are withdrawn like normal, and so are any contributions to your 401(k). If you’re maxing out your salary contributions, a bonus might put you over the limit.

A salary increase can put you over the limit as well. You may have set up your auto-contributions to max out throughout the year. If you get a pay bump, your contribution will go up as well. You may miss this increase and forget to adjust your auto-contributions.

What should you do if you over-contribute?

Since a 401(k) over-contribution can happen at any time, you should be prepared for how to tackle it if it happens to you. Keep in mind that you should start taking steps before Tax Day.

Talk to your plan administrator: Find out from your boss or human resources department who you need to talk to about your 401(k) plan. Get them on the phone and let them know you made excess contributions for the year and need to be paid back.

This takes time and not all plan administrators work quickly on these requests. Try to handle this as early as possible. You’ll need to get any excess contributions back and any earnings you made on those contributions.

Request new W-2s. You might have already gotten your W-2s from work. Once your excess contributions are adjusted, you’ll need new tax forms. Your taxable wages will now include your fixed earnings. Don’t file your taxes until you’ve gotten an updated W-2.

How are excess deferrals treated?

If you don’t handle your extra contributions by Tax Day, you’re going to be taxed twice: once for the year you over-contributed and again for the year your correction took place. You won’t be taxed twice if you made the corrective distribution before Tax Day of the year following the year the over-contribution took place.

For example, if you made a 401(k) over-contribution in 2020, you have until Tax Day 2021 to make the correction to avoid getting double-taxed.

Corrective distribution is simply when you correct the over-contribution mistake. But keep in mind that if you qualify for catch-up contributions by being 50 years of age or older, your over-contributions might save you from excess deferrals. As you’re settling this excess, knowing the tax laws can help.

Bottom line

Over-contributing to your 401(k) — even by accident — can happen to anyone. Whether you have a job change or a bump in pay, you could end up having excess contributions to your 401(k) in a few different instances. The important thing to be aware of is how to handle those extra contributions.

Make sure you contact your plan administrator before Tax Day, get new W-2s and adjust your tax bill for the upcoming year. Not handling your extra contributions could mean you get taxed twice for your contributions. This is less money in the long run that can go towards your retirement.

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