What Is a 401(k) Plan?
A 401(k) is a type of retirement savings account available to employees through an employer. Employees are able to contribute a certain percentage of their salary to the fund, which goes into the account.
The money can be invested in many different ways, depending on what investment options are offered by the employer.
Some employers even match what you put into your 401(k), up to a certain percentage. This means that the total funds in the account can be even larger.
What Is a Roth IRA
A Roth IRA is an individual retirement account with different tax benefits from a traditional IRA. With a Roth IRA, you contribute with after-tax dollars, which means you have already paid taxes on the money that goes into the account.
Withdrawals from a Roth IRA are tax-free as long as they are made after the age of 59½ and you have had the account for at least five years.
Contribution Limits for 401(k) and Roth IRA Plans
Although both plans are retirement savings accounts, each has different contribution limits.
For the 401(k) plan, the maximum contribution limit is $22,500 for 2023. A catch-up contribution of up to $7,500 is also available for people aged 50 and older.
On the other hand, the maximum contribution for Roth IRA Plans in 2023 is $6,500. Just like the 401(k) plan, a Roth IRA also allows an additional contribution of $1,000 if you are aged 50 or over. It is important to note that the amount that you are able to contribute, and whether or not you qualify to contribute at all, to a Roth IRA is based on your adjusted gross income (modified AGI) Refer to the IRS guidelines to learn more and check that you qualify before making contributions.
Maxing Out Your 401(k) and Roth IRA Contributions
The IRS restricts how much you can contribute to 401(k) plans each year because they provide such significant tax benefits. However, the potential earnings of a 401(k) are still substantial due to the fact that it allows for investment, compounding interest, and tax deferrals.
To max out your contributions for a particular tax year:
- Your 401(k) employer needs to offer you an auto-enrollment, which deducts a certain percentage of your paycheck and places it into the account. If this option is not available, you can ask your employer if they will give you the ability to establish automatic deductions from your paycheck.
- Determine how much you can contribute to a 401(k). If your employer matches your contribution, this will be the maximum allowed.
- Calculate how much you need to contribute each month to max out your contributions for the year.
- Set up an automatic transfer from either your checking or savings account to move money from those accounts into your retirement account on a monthly basis.
- Keep in mind that when you max out your contributions to one eligible retirement account, you can contribute to another type of account (traditional IRA, Roth IRA, etc.) or a combination of the two.
Maxing out 401(k) and Roth IRA Contributions Benefits
Maxing out your 401(k) and Roth IRA contributions each year has some great benefits.
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Tax-Efficient
It is tax-efficient because you will not have to pay taxes on any gains within the account, so your savings are compounded over time.
Grow More Money for Retirement
You can potentially save thousands of dollars over time for retirement. This allows you to invest more money.
Compounding Returns
You also get the benefit of compounding returns and tax-deferred growth, which is a huge advantage over other types of retirement accounts such as Traditional IRAs or Roth IRAs, which do not offer these advantages.
Easier to Contribute
When you are making contributions to an employer plan like a 401(k), it is typically easier to contribute because you do not need to take money out of your paycheck to do so.
Contributing to Both a 401(k) and a Roth IRA In the Same Year
Yes, you can contribute to both a 401(k) and a Roth IRA in the same year. However, if your income is high enough to allow it, contributions to a 401(k) may be advantageous because they reduce your taxable income.
Before contributing to an IRA instead of a 401(k) plan, compare the tax savings of your 401(k) contributions with the Roth IRA's tax benefits.
Things to Consider Before Maxing Out 401(k) and Roth IRA Plans
Maxing out your contribution solely depends on your personal preferences. However, before deciding to do so, here are some things you can take into consideration:
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Balance Savings Goal and Risks
The first thing to consider is your savings goal and the risk tolerance you have as an investor. A 401(k) plan typically invests more in low-risk, stable investments, but a Roth IRA has a higher potential for growth with lower tax benefits.
Emergency Funds
Secondly, make sure you have an emergency fund before you start investing a large amount of money. Although a 401(k) plan allows for loans, it is helpful to have emergency funds set aside for unexpected medical bills or other financial needs.
Understand Your Investment Mix
Finally, understand what types of investments are offered under your retirement accounts and ensure that you are comfortable with them.
Where to Invest After Maxing Out a 401(k) and Roth IRA
After you max out your 401(k) and Roth IRA contributions, where should you invest the remaining money?
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Invest in a Traditional IRA
You can put it in a traditional IRA. This account is invested in low-risk, safe investments such as bonds and money markets.
Invest in a Health Saving Account
You can also contribute to a Health Savings Account (HSA) if you have one. The benefits of a HSA include tax-deductible contributions and tax-deferred growth until withdrawal, meaning they offer an attractive option for retirement savers who want to save money.
Invest in a Brokerage Account
If your income is below a certain amount, you can open a brokerage account and invest in a mix of stocks and bonds that will help to diversify your investment portfolio.
Invest in a Company Stock Fund
If there is a company stock fund available, another option would be to invest some money into the plan as this is usually one of the lowest-risk options available (however, you will want to diversify your investments outside of just company stock plans).
Real Estate Investment Trusts (REIT)
Investing in real estate is another option. As the price of real estate fluctuates, REITs seek to purchase different types of real estate, including buildings, land, apartments, and mortgages.
Index Funds
Investing in index funds is another option. Index funds usually provide a higher rate of return than other types of investments, but with less risk.
Key Takeaways
Maxing out 401(k) and Roth IRA accounts are two of the best ways to save for retirement. It is beneficial because you can make contributions pre-tax, allowing for easy saving without taking money out of your paycheck.
You contribute to both a 401(k) account and an IRA in the same year, keeping more of your money in your pocket because it reduces your taxable income, increases your tax benefits, and sets yourself up for a successful retirement.
However, do not believe that you must quit saving once you have used up all of your company's 401(k) and Roth IRA contributions for the year. This might be a mistake that prevents you from achieving your retirement objectives.
You can also explore other investment options that will help you grow your savings for retirement. Talk to your financial advisor to know more.
FAQs
1. Can I contribute to both a 401(k) and a Roth IRA in the same year?
Yes, as long as you meet the eligibility requirements for each account.
2. What are the benefits of maxing out my 401(k) and Roth IRA in the same year?
Maxing out contributions will allow your money to grow faster than if you were to make the individual contribution limits.
3. Will maxing out my 401(k) and Roth IRA help me save for retirement?
Yes, the benefits of growth apply to both types of plans and can be a great way to reach your long-term goals.
4. How much money should I save to max out contributions in a 401(k) Plan?
For the 401(k) plan, the maximum contribution limit is up to $20,500 for 2022. A catch-up contribution of up to $6,500 is also in place for people aged 50 or older.
5. How much money should I save to max out contributions to the Roth IRA Plan?
For Roth IRA Plans, the maximum contribution is maxed at $6,000 for 2022. It also allows an additional contribution of $1,000 if you are age 50 or over.
