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 may not have not been reviewed, commissioned or otherwise endorsed by any of our network partners or the Investment company.

Written By

Updated on Wednesday, December 9, 2020

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 the 2021 tax year, the contribution limits for a Roth IRA and a 401(k) are $6,000 ($7,000 if you’re 50 or older) and $19,500, 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.

The “Find a Financial Advisor” links contained in this article will direct you to webpages devoted to MagnifyMoney Advisor (“MMA”). After completing a brief questionnaire, you will be matched with certain financial advisers who participate in MMA’s referral program, which may or may not include the investment advisers discussed.