As you change jobs or careers, it's almost inevitable that you’ll end up with more than one type of retirement account. What's the best way to handle them? Can you fund an IRA if you have a 401k? Is it wise to have multiple accounts, or should you keep all your money in one basket?
In order to know what's best in your situation, you need to understand how different types o retirement accounts work, and then how best to combine them.
1. Traditional employer-sponsored plans (401k, 403b, TSP). With company plans, your contributions are deducted from your paycheck before taxes are taken out, and your savings grow tax-free. But you do pay taxes when you withdraw the money in retirement, that's why these accounts are called "tax-deferred"; you don't have to pay any tax on the money until you withdraw it.
Often these plans include an employer match. For example, your company may match 50% of what you contribute, up to 6% of your salary. So if you save, say, 10% of your salary, you’d get an additional 3% from your employer. Typically your account "vests" over a period of time, so you'd usually get your employer's share after a year or two or five (check with your company).
2. Traditional individual accounts. These include traditional IRAs, solo 401ks (accounts that you set up when you work for yourself, and SEP IRAs (which can be set up by self-employed people, or a small business employer). These are tax-deferred, just like a company plan.
3. Roth accounts (tax-free on withdrawal). Whether you’re dealing with an individual Roth account or a Roth 401k (a relatively new type of retirement plan), you deposit after-tax dollars, and your savings grow tax-free. Most important, you don't pay any taxes (none!) when you withdraw the money in retirement. The ability to contribute to a Roth IRA is subject to an income cap (see "Restrictions" below).
How many accounts is too many?
The more accounts you have, the more you’re going to pay in account fees, minimums, investing charges, etc. You’ll also likely have more of a hassle at tax time.* Plus, it’s much harder to manage your asset allocation (i.e. the mix of funds in your portfolio) when you have multiple retirement accounts.
You’ll typically save money (and time) when you roll over old 401k accounts and consolidate IRAs. At Betterment we make IRA account set up and IRA rollovers efficient and secure. You can learn more here.
That said, the IRS does allow you to combine an employer plan (like a 401k or 403b or TSP) and also put money into a traditional IRA or Roth IRA, with some restrictions. So if you're careful in combining accounts, having more than one can enable you to save more.
Also, there may be an advantage to combining both tax-deferred and after-tax (Roth) accounts. Your tax bracket in retirement may be different than the one you’re in now, so funding both types of accounts gives you more options in retirement, tax-wise.
Now for the restrictions
1. There are restrictions on how much you can contribute to different accounts.
The 2014 contribution limit for a 401k is $17,500; $23,000 if you’re 50 and over.
Then you can also deposit up to $5,500 in a Roth or traditional IRA for 2013 or 2014 ($6,500 if you’re 50 and up). That’s the combined limit for both types of IRAs, by the way; you can’t put $5,500 each into an IRA and a Roth IRA.
If you’re maxing out your 401k and have more to save, opening a traditional or Roth IRA can help you sock away another $5,500 or $6,500 a year. The deadline for contributing to a traditional or Roth IRA for 2013 is April 15, 2014.
2. Then there are restrictions on how much you can deduct from your taxes.
If you’re contributing to a 401k or other employer plan, you can open a traditional IRA as well, but you may or may not be able to deduct that chunk of savings from your taxes, depending on your income.
Still, it does let you save more, and the gains grow tax-deferred.
3. Last, there are specific income restrictions on Roth accounts.
If you're married and filing jointly, and your modified adjusted gross income is $181,000 or less in 2014, you can contribute the full amount in a Roth (if you're contributing for 2013, the income limit is $178,000). As your income rises above $181,000, your ability to contribute phases out. Read details on Roth IRA limits here.
*Betterment is not a tax advisor, nor does the content of this article constitute tax advice. If you have questions on your individual situation, please consult a tax professional.
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