Contribute to 401k and Roth IRA?

July 20, 2010 12:27 PM

Should I invest in both a 401k and Roth IRA?

I am 25 with a base salary of $80k and bonuses that push me into the $90-100k range. I currently contribute the max my company will match into our 401k (six percent). After seeing my 401k grow minimally the last two years at a previous job, I am wanting to open a Roth IRA and contribute the max every year. This is where I have my questions.

Is it common to contribute to both a Roth IRA and a 401k? Or am I better off putting that ~$400/month for the 401k somewhere else?

I have just purchased the Boglehead's Guide and will be taking a look at that. I also don't mind setting up an appointment with a professional if need be to get everything in order.

posted by jwfree to work & money (23 answers total)

You are getting pretty close to the income limits for a Roth IRA; depending on how things shake out with your bonuses at the end of the year, you might not be eligible. Sounds like it might be good to hold the money over the year, see how your income stacks up, and contribute after you know you are eligible.
posted by ThePinkSuperhero at 12:33 PM on July 20, 2010 [1 favorite]

I forgot to mention that I started this job mid-year, so the income limit shouldn't be an issue this year. Next year though it could come into play. I'm not sure how that would work though since I wouldn't have any idea how much in bonuses I would be receiving. If I contribute for nine months to a Roth IRA next year and month ten I receive a bonus that knocks me over the limit, I'm not sure what would happen then.
posted by jwfree at 12:40 PM on July 20, 2010

I believe you would have to withdraw your contributions.
posted by ThePinkSuperhero at 12:47 PM on July 20, 2010 [1 favorite]

IANYF(inancial)A(dvisor). But I'd counsel anyone to always take the matching first. Especially if your employer is matching dollar for dollar - essentially, you're seeing a double return on your money. Please don't discount the built-in 200% return you're getting from the match at the getgo - you are highly unlikely to do better on your own in this scenario!

But I'm not surprised you don't see much growth in your account over the past 24 months - remember, you're starting in July 2008 for comparison (and then probably cratering from Sept-March '08).

That said, the fund options available through folks' workplaces are often less than ideal, so it doesn't make much sense to go beyond matching - any additional money you want to set aside for retirement, I'd put into the Roth. If the returns on 'growth' focused funds offered through your 401(k) plan are particularly abysmal (as a starting point, take a look at their 1, 3 & 5 year returns and fees relative to, say, some of the offerings from Vanguard), you might think about using the 401(k) to hold the more conservative piece of your portfolio mix in the future... low fee, low risk holding places where you can park your money and take advantage of the built-in bonus cash from your employer.
posted by deludingmyself at 12:48 PM on July 20, 2010

On re-reading the description header, I see perhaps you're talking about $400 above and beyond the matching amount. Oops!
posted by deludingmyself at 12:50 PM on July 20, 2010

One common strategy is:

1) 401(k) up to employer match
2) Roth IRA up to max of $5000
3) 401(k) up to max of $15,500

This is pretty much just hedging your bets, because the Roth is after-tax and the 401k is pre-tax. So whichever way the future tax climate goes, you are only half-screwed.
posted by smackfu at 12:53 PM on July 20, 2010 [6 favorites]

I would go for the 401(k) contribution before the Roth IRA contribution. Since 401(k) contributions come from the top bracket of taxation (i.e. a $100 non-Roth 401(k) contribution saves you $28 in taxes when you're in the 28% bracket) but Roth contributions are subject to your average taxation rate (i.e. when you pay in $100, you're only saving your average rate of ~18% on the other side), it's extremely difficult to come up with realistic scenarios during retirement in which it's a tax advantage to have made a Roth contribution compared to a non-Roth contribution.

Lots of people don't believe this and will say "it's the same either way!" without actually making a spreadsheet that takes the two in to full comparison.
posted by 0xFCAF at 1:00 PM on July 20, 2010

@deludingmyself: I was just referring to the ~$400 that I currently put into my 401k per month. I was just wondering if it would be more beneficial to opt out of the 401k and put that money elsewhere. Thanks for the helpful info though!
posted by jwfree at 1:03 PM on July 20, 2010

One nice thing about the Roth is that you can just dump $5k into it all at once, if you have spare money around. Can't do that for the 401(k). And actually, you can wait until next April to contribute the amount for this year.
posted by smackfu at 1:05 PM on July 20, 2010

I think it is fairly common to contribute to both. I follow the strategy smackfu outlined, and contribute to my 401(k) up to my match, then to my Roth IRA to the max, then to my 401(k).

Remember: the differences are in when the money is taxed, and of course the variety of funds you have available to you. Your comment about seeing my 401k grow minimally the last two years is what makes me say this. If you contributed the same amount of money to a 401(k) and to a Roth IRA that was invested in very similar funds, you would have about the same amount of money in each at the end of the year.
posted by teragram at 1:12 PM on July 20, 2010

If you can afford to contribute to both, you absolutely should! It diversifies your retirement savings and allows you to save more. You should particularly contribute to the Roth now while you're eligible.

Full disclosure: I contribute to the match for my 401(k) and max out a Roth (and I make about half what you do). When student loans are all gone, I'll add more to the 401(k) as smackfu outlines.

Have you taken a look at any retirement calculators to see how much you need to retire on? I do think it's possible to save too much for retirement, at the expense of enjoying life now, but I don't think you can go wrong with contributing to the max of your 401(k) and maxing out a Roth.
posted by peanut_mcgillicuty at 1:25 PM on July 20, 2010

I contribute to both.

Like others have posted, take advantage of any company match into your 401k that you get, because that's free money. After that I max my Roth IRA contribution ($5k per year), and then contribute whatevers left to my 401K.

I choose to pay the tax now (Roth), rather than later (401k). I feel that having a lot of money in my roth IRA when I retire will allow me to control/limit the amount of money I have to withdraw from my 401K account. That will allow me to remain in the lowest possible tax bracket, since withdrawing money from a 401K essentially counts as income.

IANYFinancialAdvisor, and there are many differing opinions.
posted by Arbitrage1 at 1:34 PM on July 20, 2010

Paraphrasing from another web site (cited below):

1) Max out any 401(k) match that the company provides
2) Max out the $5,000 for the Roth IRA
3) Max out the rest of the 401(k) as much as you can, up to $15,000

This matches the advice from smackfu and teragram. In practical terms, this means you should deduct $192.30 from each paycheck to your Roth account, assuming your company pays every 2 weeks with 26 pay periods. Then figure out how much more you want to devote to your 401(k), above and beyond the 6% match.

It's unclear how much you're planning to save each year in total, but I would recommend 10% or even 15%. Since you're a young professional, I would highly recommend this book.

http://www.iwillteachyoutoberich.com/blog/the-worlds-easiest-guide-to-understanding-retirement-accounts/

Key themes from the book:

* Automate your finances as much as possible. Don't say to yourself, "I'll leave $5K in my savings and send it to the Roth at the end of the year." Just send $192.30 with each paycheck, and fix it later if your bonus makes you ineligible.

* Retain the "student lifestyle" as long as possible. Avoid the temptation for your lifestyle expand to consume your salary. As you grow older, you'll discover expenses that you never had before (house, wedding, kids, or maybe 2 years in South America!). You'll appreciate that you saved a high percentage for your retirement early in the game.
posted by jtherkel at 1:53 PM on July 20, 2010 [1 favorite]

As a practical note, if you are going to hit the Roth income limits soon, it may not be worth contributing $5k for only two years, just because you'll have to manage that small account for the next 40 years. Roth are pretty low maintenance tax-wise but its still a lot of account statements and such.
posted by smackfu at 2:06 PM on July 20, 2010

As a practical note, if you are going to hit the Roth income limits soon, it may not be worth contributing $5k for only two years, just because you'll have to manage that small account for the next 40 years. Roth are pretty low maintenance tax-wise but its still a lot of account statements and such.

Ten k compounding tax free for forty years is probably worth a little effort.
posted by IndigoJones at 3:22 PM on July 20, 2010

If you can, do it! My husband contributes to both a 401(k) and a Roth IRA. Since I'm self-employed, I don't have a 401(k), but I contribute the maximum to both my SEP IRA and my Roth IRA.
posted by lgandme0717 at 3:39 PM on July 20, 2010

I believe that Modified Adjusted Gross Income (the salary amount that's used to determine how much you can contribute to a Roth IRA) is lowered by any contribution to your 401(k) account. That means that if your earnings do get into the range of $101K to $116K (the range at which the amount you can contribute to a Roth account starts going down), you might be able to increase the amount you're allowed to contribute to a Roth by also increasing the amount you contribute to a 401(k).

If you think that may be the case for you, it would make sense to contribute more to your 401(k) now since those contributions happen with every paycheck while you could contribute to the Roth with a single lump sum much later.
posted by willnot at 4:25 PM on July 20, 2010

I contributed to a Traditional 401k and Roth IRA at the same time. (Definitely take the match!) When my company started offering a Roth 401k option, I switched to that. Perhaps another option if your company offers it.
posted by aloysius on the mixing boards at 6:10 PM on July 20, 2010

Yeah, it was always my understanding that if you make $115K, contribute $15K to a 401(k), for all intents and purposes your income is now $100,000 - allowing you to contribute the max to both.

I would definitely, definitely contribute to a Roth. When the time comes, it's tax-free. If you look at the US now, it's absolutely unsustainable at the low tax rate we have now (unless we have a reduction of services or some miracle growth engine). If taxes go up, withdrawing from that 401(k) in the future is going to be expensive....
posted by unexpected at 6:13 PM on July 20, 2010

If they don't start taxing Roth widrawals. That's the problem with predicting the future.
posted by smackfu at 6:48 PM on July 20, 2010

A tip for when you hit the income limits for a Roth IRA:

Contribute 5k to a non-deductible IRA the year you're over your limit. Then, next year, convert it to a Roth IRA. You can do this every year starting this year.
posted by shew at 9:57 PM on July 20, 2010

A tip for when you hit the income limits for a Roth IRA:

Contribute 5k to a non-deductible IRA the year you're over your limit. Then, next year, convert it to a Roth IRA. You can do this every year starting this year.

You don't have to wait a year to do the conversion. You can do it the next day if you like. It remains to be seen how long this loophole will remain.
posted by JackFlash at 11:26 PM on July 20, 2010

I'm not sure how that would work though since I wouldn't have any idea how much in bonuses I would be receiving.

One note on this: you have until April 15 of the following year to make your Roth contribution for a given year. I.e., you can make a "2010" Roth contribution up until April 15, 2011. (With my broker, if I make a deposit to my Roth between Jan. 1 and Apr. 15, they specifically ask if I want it to count towards that year's or the previous year's contribution.) So you can wait and see how much you've made, and then make the maximum deposit based on your income.
posted by DevilsAdvocate at 1:11 PM on July 22, 2010