How to Contribute to Both a 401K and a Roth IRA

By Shani Valdez

  • Overview

    The 401(k) defined contribution plan is a great way to reduce your taxable income by deferring a percentage of your salary into an employer-sponsored 401(k) plan. Typically, many employers match employee contributions. Income tax is collected on the back end with contributions and earnings withdrawals. 401(k) contributions do not affect your ability to contribute to a Roth IRA. If you qualify to make Roth IRA after-tax contributions, which allow for tax-free earnings growth, and can defer some of your salary to a 401(k), you should make every attempt to do so.
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  • Contribution Overview for 401(k) and Roth IRA Accounts

    • Step 1

      Make sure the paperwork needed to establish these accounts is completed and submitted by the deadline. Employer-sponsored 401(k) plans have a once-a-year window for establishing new accounts and changing salary-deferred investment percentages. A Roth may be established at any time, but prior-year contributions need to be made by the tax deadline, April 15.

    • Step 2

      Ascertain how much you can contribute to both your 401(k) and Roth IRA. 401(k) plans are rife with government rules and regulations, so check the contribution limits yearly. Roth IRA contribution limits are the same as for traditional IRAs, but MAGI (modified adjusted gross income) requirements may affect your ability to make full or partial contributions to a Roth. Once you have determined your contribution amounts for your 401(k) and Roth IRA, divide that dollar amount by the amount of paychecks you get every year. That is how much you would need to pay per check for both retirement plans.
    • Step 3

      Determine your asset allocation for your contributions. Match your allocation to your time horizon, age and risk tolerance. An investment adviser can help you with this if you're unsure of how to invest your contributions. Defined contribution plans are limited in investment choices compared to self-directed retirement plans. Therefore, expect limited investment choices for your 401(k) versus your Roth IRA.
    • Step 4

      Re-balance your retirement portfolios often. You want to be sure your investments are meeting your investment objectives. Keep in mind, however, that if you're a ways from retirement, you should be investing for the long term, you should expect market fluctuations with your investments, and you shouldn't be day-trading in these accounts. If you're 3 to 5 years from retiring, you need to start modifying your asset allocation to start reflecting more of a conservative investment approach. The end goal should be to outpace inflation while limiting market swings, as would be seen in aggressive-growth portfolio allocations.
    • Step 5

      Be aware of age requirements when it comes to contributions and withdrawals. Roth IRA provisions have not imposed age requirements like traditional IRAs in regards to annual contributions. You may contribute as long as you have earned income, you can withdraw contributions anytime, and you may withdraw earnings tax- and penalty-free after age 59-1/2 as long as the account has been open a minimum of 5 years. 401(k) plans require you to start distributions at age 70-½; otherwise, you will face a severe 50 percent penalty on the required withdrawal from the IRS. 401(k) plans may be rolled into a rollover IRA. Once investments are in the rollover IRA, they are subject to traditional IRA provisions pertaining to contribution limits, contribution tax-deductibility and age requirements for contributions and withdrawals.
    • Skill: Moderately Easy
    • Tip: There are a lot of useful calculators you can use to see how your taxes are affected by 401(k) contributions and the difference made from tax-free earnings growth.
    • Tip: Compounded tax-free earnings growth can add up to more money in your pocket. Look at Money e-zine's Roth versus Traditional IRA calculator (see Resources) to compare the net income after taxes for pretax and after-tax contributions as annualized income.

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