Should I save in my Roth IRA or 401k?

April 13, 2015 12:00 am
Chrissy

Christine H. Canapari, ChFC®

Senior Financial Advisor & Manager of Client Services

The decision to invest in a 401k or a Roth IRA can be challenging.  After all, both options have significant tax benefits. However, when you get to experience the benefits usually occurs at different times in the investor’s life.  The 401k option offers an immediate tax deduction because contributions are made on a pre-tax basis.  No tax is owed on the amount contributed.  You do not receive a tax deduction on contributions made to a Roth IRA, however your investment offers tax free growth and is able to be withdrawn tax-free (with a few exceptions) after age 59 ½.  I should mention that not everyone is automatically eligible to contribute to a Roth IRA.  Your modified adjusted gross income (MAGI) is used to determine eligibility.  The income limitations and phase out ranges for 2015 are below with MAGI below the range being eligible.

Filing status: Single
MAGI range: $116,000–$131,000

Filing status: Married, filing jointly
MAGI range: $183,000–$193,000

If you are in a position to both max out your 401k (or other employer sponsored retirement plan) and contribute to a Roth IRA, I would recommend doing so.  If you are not in that position and have to make a choice, here are some strategies to consider.

Combine 401k and Roth Savings
If you are at a point in your career where your salary still allows for Roth IRA contributions, you may want to forgo some 401k contributions and take advantage of the Roth opportunity.  Now you don’t want to miss out on any company match while doing this, so you need to plan wisely.  Let’s suppose that you have allocated $10K of your $100K salary to be saved for retirement this year.  Your company matches up to 5% of your salary up to your contribution.  So in this scenario you could contribute 5% to your 401k in order to get your full company match and still have another $5K to invest in a Roth IRA.  With no company match, you may wish to consider making a maximum Roth IRA contribution ahead of contributing to your 401k.

Take Advantage of Lower Income Years
An opportunity sometimes arises for married couples when one spouse is temporarily home raising children.  As a working couple you may not have qualified for Roth contributions because your joint income was too high.   If on one income you qualify to make contributions, you will want to take advantage as the chance may no longer be available when both of you are working again.  An added bonus in this scenario is that a spousal contribution can also be made for the non-working spouse.  Again here, as in the first scenario, you may want to consider allocating more contributions to Roth IRAs than a 401k if the Roth’s availability will be limited to your family in future years.

Careful consideration should be used when deciding where to save for retirement in any given year.  What may be appropriate for you may differ greatly for others because everyone’s financial situation is unique. You must weigh the current tax benefits of the 401k against the future tax benefits of the Roth IRA.  Both your financial advisor and your tax preparer can help in outlining the choices and potential outcomes.

Chrissy Canapari serves as Financial Advisor and Manager of Client Services at StrategicPoint Investment Advisors in Providence and East Greenwich. You can e-mail her at ccanapari@strategicpoint.com.

The information contained in this post is not intended as investment, tax or legal advice. StrategicPoint Investment Advisors assumes no responsibility for any action or inaction resulting from the contents herein. Chrissy’s opinions and comments expressed on this site are her own and may not accurately reflect those of the firm. Third party content does not reflect the view of the firm and is not reviewed for completeness or accuracy. It is provided for ease of reference.