You may feel pretty good about your retirement plan if you have a company 401(k). And you may even feel great if your employer matches your contributions—because, hey, free money! But if you’re like most people, you still wonder if your savings will keep up with those birthdays.
Both 401(k) plans and IRAs are designed to help you save for retirement, and both have various benefits. Here’s why you may want to consider using these tools in tandem to maximize tax breaks, save more, and diversify your retirement savings.
You’re reaching the contribution limit to your employer’s plan.
If you’re under age 50, the 2018 annual contribution limit for 401(k) plans is $18,500; it’s $24,500 for those ages 50 and older. If you find yourself nearing that limit each year, you may be looking for places to park some extra retirement cash.
An IRA will let you put away another $5,500 per year if you’re under 50; $6,500 if you’re age 50 and older. That can really add up over time, especially when you consider the beauty of compound interest. Check the IRS website for current contribution limits and eligibility requirements.
You want more investment flexibility.
Most 401(k) plans don’t offer a lot of investment options. 401(k) plans are opened and directed by your employer. You may find a plan here and there that comes with a self-directed account option, but that’s uncommon.
Since you open an IRA yourself, your options are wide open. You have a number of IRA invest products to choose from, including a variety of mutual funds, exchange-traded funds (ETFs), and individual stocks and bonds.
You can also open IRA deposit products, like savings accounts and certificates of deposit (CDs), that are FDIC-insured up to the maximum allowed by law.
You want more control over your tax situation.
The best thing about 401(k) plans and IRAs is their tax advantages, so it makes sense to put some thought into how those work for you both now and later. 401(k) plans and traditional IRAs are tax-deferred, meaning you don’t pay taxes on the money you put in now, but you do when you withdraw it.
That means you’ll have to pay taxes during retirement on the money in your 401(k). In order to offset some of those tax payments, you may want to fund a portion of your retirement savings with post-tax dollars. Experts call this tax diversification, and it’s meant to reduce your tax burden during retirement when you start withdrawing all those tax-deferred dollars.
One way to do that is with a Roth IRA. Since you’ve already paid taxes on the money you contribute to a Roth IRA, you don’t have to worry about paying taxes on your earnings or qualifying withdrawals in retirement.
You’ve done the math and there’s a gap.
Only you and your financial advisor can figure out how much you’ll need for the lifestyle you want during retirement. But if you keep coming up short when you run the numbers, it’s time to save more.
Easier said than done, for sure. But one way to save more is to maximize the best of what a 401(k) and an IRA have to offer. A tried-and-true strategy is this: first, contribute enough to your 401(k) to get the maximum employer match. Then, open either a traditional or a Roth IRA and contribute the annual maximum. Then, contribute more to your employer plan until you hit the annual maximum there, too, if possible.
A tax professional can help you get the right mix of retirement savings products for your situation. It’s also a good idea to visit the Internal Revenue Service website for specific, up-to-date information.
Discussion: When to Supplement your 401(k)
- How are you supplementing your employer-sponsored retirement plan?
- When is a good time to add an IRA to your retirement portfolio?
- How do you make saving for retirement a priority?