Joel’s Published Column

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401K Vs. Roth IRA

Clients often ask whether they should utilize a 401K plan or a Roth IRA. Here is a quick outline to help:

The benefit of a 401K plan is deferred taxation on portions of your current income until retirement, when you will hopefully be in a lower tax bracket. The money you put away, plus the growth on that money, will be taxed at a lower level when you withdraw it. In theory, this will work out well as long as taxes do not increase (a real possibility). One HUGE benefit to employees with a 401K plan is an employer matching provision. If this is the case at your company, take advantage of that benefit to the fullest extent! It’s free money!! A five percent match means you contribute five percent of your yearly income and your employer puts in five percent too. It’s like getting a 100% rate of return annually!

The Roth IRA is an Individual Retirement Account that allows you to invest money after you’ve paid taxes on it. You do not get to write off the amount you put into this account on your current taxes like you do with a 401K contribution, but funds in your Roth grow tax-free. At retirement, you get to withdraw qualified amounts without paying taxes on it! I encourage the use of the Roth IRA as a retirement savings vehicle because it eliminates future tax policy as a variable. The national income tax could increase to 50%, but in theory, the money you withdraw as a qualified distribution will have no tax.

When faced with a choice between saving through a 401K plan or a Roth IRA, here are some questions to ask:

  • Does your Employer Match any portion of your contribution?
  • If yes, then put in at least up to the amount they match (it’s free money!)
  • Do you think taxes will decrease in the future?
    If no, you probably should start saving some money in a Roth IRA.

I often advise people to put into their 401K plan at least what their employer will match, and if there is money left over put the remainder into a Roth IRA. This provides two different pools of money to draw from during retirement.

As always, these are general rules and your own personal situation should be reviewed with a financial advisor.

IRA Funding Season

There are many different rules regarding IRA and Roth IRA contributions. The government gives us a small window of time from January 1 through April 15 during which we can actually make contributions in the current calendar year for last year. So if you forgot to make your 2015 full contribution, it’s not too late.
Before making contributions to an IRA or a Roth IRA, you must qualify by having earned income – this could be anything from payment for babysitting services that you claim, to working at a restaurant, to punching the clock over at the truck and bus plant. If you have the ability to contribute to a 401K plan or other qualified savings account at your place of employment, you could be unable to make deductible contributions to your IRA if you make too much money. The graph below includes the income levels provided on Fidelity Investments’ website at www.fidelity.com.
Roth and Traditional IRA contribution limits
How much you can contribute for each tax year

Age 49 and under
2015 = 100% of compensation, up to $5,500
2016 = 100% of compensation, up to $5,500

Age 50 and older
2015 = Additional $1,000
2016 = Additional $1,000

To be eligible to make a contribution to a Roth IRA or a deductible contribution to a Traditional IRA, an individual’s modified adjusted gross income (MAGI) must be less than a stated amount, depending on tax-filing status. Here are the MAGI limits for 2015 and 2016:

Roth IRA modified adjusted gross income phase-out ranges*
The income ranges in which you can make a partial contribution to a Roth IRA

Single individuals
2015 = $116,000–$131,000
2016 = $117,000–$132,000

Married, filing joint returns
2015 = $183,000–$193,000
2016 = $184,000–$194,000

Traditional IRA modified adjusted gross income limit for partial deductibility
The income ranges in which you can make a partially deductible Traditional IRA contribution

Single
2015 = $61,000–$71,000
2016 = $61,000–$71,000

Married, filing joint returns
2015 = $98,000–$118,000
2016 = $98,000–$118,000

Married, filing separately
2015 = $0–$10,000
2016 = $0–$10,000

Non-active participant spouse (i.e., those with spouses who earn no income)
2015 = $181,000–$191,000
2016 = $183,000–$193,0

As we approach that April 15 deadline for 2015 contributions, you may want to consult with your financial advisor and your tax advisor regarding your personal tax situation. Also, if you are lucky enough to make more than the allowable amount to contribute to a Roth IRA, you may still be able to get that funded.