401(k)s and Roth IRA(s)

Both 401(k)s and Roth IRAs are popular tax-advantaged retirement savings accounts that differ in tax treatment, investment options, and employer contributions. You can look at thisĀ 401k vs ira comparison to learn more about them.

Can I Fund a Roth IRA and Contribute to My Employer's Retirement Plan?

The tax treatment of the 401(k) and Roth IRA is often confusing. The 401(k) and Roth IRA provide different tax treatment.

401k vs. IRA Tax Treatment
The tax treatment of a 401k and Roth IRA is determined by whether the accounts are operated as a retirement plan, a money market account, or a brokerage account.

A 401k account is a retirement plan. If a 401k account is operated as a retirement plan, it will generally pay you tax at ordinary income tax rates and have a tax-deferred withdrawal of earnings. The tax code also allows for an employer to deduct from the employee’s 401k contribution an amount equal to the employee’s contributions to the 401k. So, a contribution of $4,000 to a 401k will save the employee $2,000 of taxes by the time it is taken out of the 401k account and paid out as income tax.

A Roth IRA is a money market account. This means that the 401k contributions will be paid from a portion of the employee’s earnings in the 401k. When the account is depleted, the funds will be rolled over to a Roth IRA. Thus, in order to have your money in the Roth IRA, you have to withdraw that money from the 401k at retirement. The withdrawals from the 401k are paid to your employer in a monthly check, and then your earnings in the 401k are withdrawn and paid to your Roth IRA.
In this manner, your Roth IRA is paid for by your 401k.

It is interesting to note that the employer has no liability for the Roth IRA withdrawal, as the contributions that were made are rolled over to your Roth IRA and the withdrawals from the 401k are not paid to your employer. Therefore, as long as the employer is paying for the contributions, it doesn’t matter whether the employer has to pay the employer-deducted contributions.

Another way that Roth IRA accounts pay for your employer-deducted contributions is by reducing your taxable income. Since Roth IRAs pay for your employer-deducted contributions, you will be allowed to keep more of your own income and pay less tax. This is true even though the Roth IRA can only be opened after age 59. Roth IRAs are also better for your tax strategy than traditional IRAs. By making the Roth IRA contributions, you will be eligible to take advantage of the lower tax rate on Roth contributions. The only other difference between a Roth IRA and a traditional IRA is that the Roth IRA does not include a 10% early withdrawal penalty. You can have both.

If you have a traditional IRA at work, you should talk to your employer to make sure you’re contributing on time. Many employers take their fair share of taxes, so they are not likely to approve a Roth IRA without additional income verification from you.

How do I contribute to a Roth IRA?

You can contribute up to $5,500 to a Roth IRA each year, up to a maximum of $5,500 per tax year. After you reach the annual limit, you can continue to contribute until you reach the $5,500 catch-up limit or until you reach age 70 1/2, whichever comes first.

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