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Roth IRA and 401k: A Smart Investment Pairing

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 has not been previewed, commissioned or otherwise endorsed by any of our network partners.

Investing for retirement can seem to be an overwhelming task. There are many different types of retirement accounts that all offer different benefits.

You’ve likely already heard of 401(k)s and Roth IRAs, and may be trying to decide which is best for your retirement savings. Each of these accounts offers different benefits. The good news: You don’t have to choose just one.

Can you have a 401(k) and a Roth IRA?

Yes, you can have both a Roth IRA and a 401(k) account. You are even able to contribute to both accounts within the same year. You’ll need to qualify for eligibility in both types of plans, but there’s no type of restriction that says contributions to one kind of account limit your ability to contribute to the other. So, if you’re a retirement savings overachiever, go for it!

To be eligible for you a 401(k), your employer must offer a plan. Anyone can open a Roth IRA if they fall below the income limits set by the IRS.

Keep in mind that the IRS also sets limits on how much you can contribute each year for both 401(k) and Roth IRA accounts.

Benefits of having both a 401(k) and Roth IRA

Tax diversification. While contributions made to a Roth IRA are made after-tax, contributions to a 401(k) are made pre-tax — but you’ll pay taxes either way. However, when it comes time to withdraw money for retirement, you’ll have more options and should be better able to minimize your tax burden.

Age and income factors. Roth IRAs have contribution limits based on your income. “Usually, for younger folks, it makes sense to prioritize the Roth IRA because they are usually in a low tax bracket now, will be in a higher tax bracket later and have many decades for the Roth IRA to grow,” said Kenneth Melotte, a certified financial planner.

The contributions made to a 401(k) are not limited by income. The most important thing is to contribute enough to gain your employer match. After that threshold, a Roth IRA may be the right place for your money. However, it will depend on your exact situation.

Flexibility. 401(k) plans typically have fewer investment options available than Roth IRAs have. More investment options mean you can better diversify your investments and shop around for low-fee options more easily with a Roth IRA.
“If someone is eligible to contribute to both a 401(k) and an IRA, I will sometimes recommend they contribute enough in the 401(k) to get the full match from their employer and then put any excess monies available for investing into the IRA,” said Melotte.

Access to funds. “The main drawback I see with Traditional IRAs and 401(k)s is a lack of liquidity,” said Chad Manberg, a certified financial advisor. “I run into investors all the time who have done a terrific job in saving, but a poor job in cash flow planning.”

Roth IRAs allow you to withdraw your contributions without penalty in a number of different circumstances. This makes money more accessible if you find you need to withdrawal some before you hit retirement age.

Increased savings. Each type of retirement account has contribution limits that can restrict your overall savings. In 2019, the contribution limits for a Roth IRA and a 401(k) are $6,000 ($7,000 if you’re 50 or older) and $19,000, respectively. If you plan to save more than the limit of either account, then you should consider opening both. Choosing just one account would limit your ability to save for retirement in a designated retirement account.

The Bottom Line

Roth IRAs and 401(k)s are each great retirement tools on their own. When combined, they give you even great flexibility and diversification. Take a look at your circumstances including income, age, and how much you can save this year and then decide if one or both is right for you.

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Investing

5 Things to Know About Using Your Roth IRA as an Emergency Fund

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 has not been previewed, commissioned or otherwise endorsed by any of our network partners.

Emergencies happen to everyone. Unless you are living under a very lucky star, you will likely encounter a major financial emergency at some point in your life. The problem is that you cannot predict when it will happen.

If you run into a financial emergency, then you need to be aware of your options. One route is tapping into your Roth IRA account in order to fund the emergency. Although taking money out of your Roth IRA is not an ideal financial situation, it may be more advisable than taking out a loan from your 401(k) or taking out a high interest loan.

What to know before using your Roth IRA as an emergency fund

Before you decide to take money out of your Roth IRA in an emergency, you need to understand what is at stake and how to minimize your losses.

1. Take out only what you absolutely need

The general idea of a Roth IRA is to allow your after-tax money to grow and be withdrawn tax-free during retirement. When you choose to take money out of your Roth IRA early, you are losing out on the potential for compounding interest that can really grow your investments.

Remember, this account is one of the ways you can save for retirement. If you withdraw money from your account early, then that may result in postponing your retirement to a later date.

2. Understand contributions vs. earnings

You can take out money you’ve contributed to your Roth IRA any time, without penalty or tax. But, if you want to take out earnings — the money that you’ve made from investing your contributions — you could be subject to a 10% penalty on that withdrawal.

All distributions of earnings are subject to the 5-year rule. The rule means that if you withdraw your earnings before the Roth IRA account has been open for 5 years, then you will be required to pay taxes.

If you are under the age of 59 and a half, then you are able to withdraw money without penalties if the money will be used for one of the reasons below. However, you will still need to pay taxes on the earnings you withdraw from your account.

  • To pay for medical expenses or health insurance if you are unemployed
  • You become disabled
  • The account holder passed away
  • To pay for a first-time home purchase (up to $10,000)

If you are over the age of 59 and a half, then you are able to withdraw your earnings without taxes or penalties when you have met the five-year requirement.

3. Leave all rollover contributions in your account

If you choose to roll over a traditional IRA into a Roth IRA, that rollover is subject to a different five-year rule. In order to take a distribution without paying taxes, you will need to leave the money in the Roth IRA account for five years.

4. You will not have immediate access to the funds

Unlike your checking account, you cannot just withdraw the money from your Roth IRA for immediate access. In fact, it can take several days to secure your funds.

“It usually takes a few days, so in the real case of emergency, it is not a viable option,” said Rivi Biton, a CPA and JD at a tax firm in New York. If the financial emergency can wait for your Roth IRA distribution to come through, then you may be able to make it work. If you cannot wait for the distribution and have no other options, Biton recommended, “If credit card funds are available, using them and then paying them off with the distribution is a good option.”

It is important to get started on the distribution process as soon as you know that you need the money. Otherwise, you may not get it in time to solve your problem.

5. Invest back into your Roth IRA when the emergency is over

Once you have made it through the emergency, you will want to begin aggressively investing back into your Roth IRA. Although you will be unable to make up for lost time, you will be able to continue contributing to your Roth IRA.

Each year, you are allowed to contribute a certain amount to your Roth IRA. For 2019, you will be able to contribute up to $6,000 if you are under the age of 50 and up to $7,000 if you are over the age of 50.

The contribution window for your Roth IRA each year ends on April 15 the following year. For 2019, you will have until April 15, 2020, to contribute to your Roth IRA for the previous year. Taxes must be paid by the final April 15 date, which is why you have until then to finalize your contribution for the previous year.

Each contribution window is an opportunity to rebuild your account. When you are able to, move past the emergency and start reinvesting for your retirement.

Alternative options to fund emergencies

Tapping into your Roth IRA in the event of an emergency can seriously set back your retirement savings and it can be difficult to catch back up. But, if you can stick to just taking out your contributions and not your earnings, taking from your Roth can be a penalty-free option.

Here are a few other options to consider if you need to fund an emergency:

  • Create an emergency fund. Many recommend creating an emergency fund with between three to six months of expenses saved. The fund can help you through minor emergencies (an expensive car repair) to major emergencies (losing your job). No matter what kind of emergency life throws your way, having an emergency fund with enough cash will help see you through to the other side. At the very least it will give you a little bit of breathing room between a major emergency and finding the will to get back on your feet.
  • Liquidate a brokerage account. If you have a brokerage account that has grown over the years, it can be painful to liquidate it. However, it is an option with fewer penalties and taxes attached. You may be able to fund the emergency with the liquidated assets in that account.

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What is a 529A Account?

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 has not been previewed, commissioned or otherwise endorsed by any of our network partners.

Life can be very expensive, especially if you or a loved one is paying for disability-related expenses. The sheer amount of expenses can take a toll on any budget. Luckily, the 529A Savings Plan can help ease the burden.

What is a 529A plan?

Similar to a 529 college savings plan, a 529A plan allows you to save for a specific purpose. Instead of strictly using the money for education-related expenses — as would be required with a 529 college savings plan — you can use the money for disability-related expenses. Disability-related expenses include employment training, health care, financial management services, transportation, housing, education, and any other expense that improves the beneficiary’s independence or quality of life.

The “A” in 529A stands for ABLE (Achieving a Better Life Experience). The entire goal of this legislation is to provide a way for Americans with disabilities to save up to $15,000 per year per individual.

Each state has its own aggregate limit, which means you can’t contribute any additional funds into the account past that limit. However, if the beneficiary withdraws money from the account, you can continue adding money into the account up to the limit. For example, if a 529A account has an aggregate limit of $100,000, then you will not be allowed to contribute any more if it has reached that $100,000 threshold.

Once the funds are safely within the 529A account, you will have a variety of investment options available, which will vary by state. Many states offer ways to invest your money in mutual funds and money market funds within the 529A account. You may even have the ability to store it in a checking or savings account through your 529A.

You should also be aware that the funds in a 529 ABLE account may preclude you from collecting federal or state disability benefits. The funds are considered resources of the individual, which could affect their eligibility for certain programs like Supplemental Security Income.

Depending on the rules of your state and your unique goals, you may wish to consult with a financial planner on the best way to invest the money you are able to save in your 529 ABLE account.

Who is eligible for a 529A plan?

The beneficiary of a 529 ABLE account can be an individual of any age; however, the individual must have acquired a qualifying disability before the age of 26. If you are attempting to open a 529 ABLE account after the beneficiary’s 26th birthday, then you will need a signed letter from a doctor indicating that the disability set in before they turned 26.

The parent or guardian of the beneficiary or the designated power of attorney for the individual can open a 529 ABLE account for the beneficiary.

Tax benefits of a 529A plan

529A accounts offer significant tax benefits. Although the contributions made to the 529A account are after taxes, the earnings made within the account are not subject to federal taxes. In other words, the funds placed in this account will grow tax-deferred.

What about taxes on withdrawals? As long as a withdrawal is used to pay for a disability-related expense, the withdrawal will not be subject to federal taxes. Many states also refrain from taxing 529A withdrawals.

Finally, some states will even provide state tax deductions for state residents placing funds into a 529 account. “Individuals need to consider their state’s tax incentives in addition to federal tax benefits,” said Ksenia Yudina, a CFA with U-Nest. “In case the state doesn’t provide special tax deductions to its residents, individuals need to look at various other factors to maximize the benefits of using the accounts.”

If you are having difficulty maximizing your tax benefits, you should discuss your options with a professional in your state.

Are there 529A fees?

As with many investments, there are fees involved with 529A accounts. Depending on the specific state plan, the following are common fees you might expect with an ABLE account:

  • Disbursement fees. Only two state plans — Oregon and Texas — charge a disbursement fee. Fees may be based on plan type, such as opting for paper-statements or plans with a prepaid card, (Oregon), or for withdrawals by ACH or check (Texas).
  • Debit card fees. Some plans have the option of providing account holders with a debit card or purchasing card. Although some offer this service for free, others charge a small fee ranging from $1.25 to $2 per month, with the option of waiving the fee if you meet certain conditions.
  • Annual fees. Annual fees can range from $30 to $60 and may be broken up into monthly or quarterly payments. Some plans offer a discount on annual fees for things like opting to receive e-statements over paper statements.
  • Investment fees. These fees are dependent on the individual’s investment choices and range from 0.19% to 0.94% Louisiana’s ABLE plan is the only one that doesn’t charge investment fees.

529A Saver’s Credit

The Saver’s Credit is a federal tax credit that allows low and middle-income individuals to claim a return when they make contributions to their retirement accounts. In this case, beneficiaries of a 529 ABLE account can claim the Saver’s Credit on contributions made to the account. The amount of the credit varies based on your adjusted gross income, and can be 50%, 20% or 10% of your annual contributions made that year.

Take a look at the table below to understand how the Saver’s Credit will impact your contributions. These numbers are the adjusted annual income ranges that you would need to qualify for the Saver’s Credit.

2019 Saver's Credit
Credit RateHead of householdMarried filing jointlySingle, married and filing separately or qualifying widow(er)
50% of contributionLess than $28,875Less than $38,500Less than $19,250
20% of contribution$28,876 to $31,125$38,501 to $41,500$19,251 to $20,750
10% of contribution$31,126 to $48,000$41,501 to $64,000$20,751 to $32,000
0% of contributionMore than $48,000More than $64,000More than $32,000

States with 529A accounts

Not all states offer a 529 ABLE plan. The following states don’t offer a 529A plan: Connecticut, Hawaii, Idaho, Main, Utah, and Wisconsin. However, you may still be able to open a 529 ABLE account. Some states offer 529A accounts that accept non-residents into their state’s program.

One of the best resources to find the best option for you is the ABLE National Resource Center. It is a great place to find preliminary information about 529A account options. The website lets you compare different plans to help you narrow your options. Once you have selected a few plans, you can investigate further by visiting the program’s specific website, which is linked to on each state plan description on the website.

Bottom line

The rules of 529A plans will vary by state; however, there are many tax breaks available for those that are eligible. If you aren’t sure exactly how to maximize your tax benefits, speak with an advisor in your state to find out more about your options.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.