Can You Contribute to 401k and IRA

Can You Contribute to a Roth IRA and 401K?

Can you contribute to a Roth IRA and 401k?  Yes, you can contribute to a Roth IRA and 401K at the same time.

In this post I’ll share my experience of simultaneously contributing to a Roth IRA and 401K, as well as the requirements you’ll need to meet in order to do the same.

When it’s time to get serious about your retirement, it’s not a stretch to imagine you might start thinking beyond your 401K. If you have a 401K at work, that’s great. Your employer cares about you and your ability to support yourself in retirement. If your employer is offering a matching contribution, well, you’ve struck gold. That’s free money. The next logical step is to consider a Roth IRA.

Before you consider a Roth IRA, you should be fully taking advantage of your company 401K. By that I mean contributing enough annual dollars to get the full match that the company offers. It’s likely that you are already doing that so let’s dive into the next step of also investing in a Roth IRA.

As a side note, if you don’t have a 401K, then consider reviewing the Difference Between Roth IRA and Traditional IRA.

Difference Between 401K and Roth IRA

Remember that the Roth IRA and 401K are just accounts where you keep your investments. They aren’t actual investments. They are just the account (or vehicle, as some put it) where the money is held. These accounts are great because they get special tax treatment.

You are able to contribute pre-tax dollars to a 401K. This means that no tax is taken from your money that is placed into the 401K. If you earn a dollar and put it in your 401K, you pay $0 in taxes on that dollar. If you earn another dollar and put it in your checking account instead, you have to pay taxes on that money.

There is a limit to your contribution though. It changes every year usually, but right now you can contribute $18,500 (2018) to your 401K.

You can’t contribute pre-tax dollars to a Roth IRA. You can only contribute dollars that have been taxed already. However, unlike a 401K, when you distribute that money to yourself in retirement, you don’t have to pay a tax. Nice, huh? For more on this account see the Roth IRA Explained.

401K and Roth IRA

Because the Roth IRA and 401K have opposite tax treatments, the IRS allows you to contribute to both at the same time. The only thing you have to worry about is the income limitation set on the Roth IRA. Your ability to contribute to a Roth IRA starts to “phase out” at $189,000 (2018) for those who file “married filing jointly”.

Here’s a strategy I follow. To contribute to both of these accounts, just make sure you start with contributions to the 401K to get the match. Then, switch to contributing to the Roth IRA. Once that is maxed out for the year ($5,500 for 2018), then you can go back to the 401K until you reach your annual limit there.

I did that for the tax years 2016 through 2017 and saw significant increased in my tax-advantaged retirement investing accounts. Not to mention, I have two different account with different distribution rules. So now I can consider things like using my Roth IRA for a down payment.

How about you, do you contribute to a Roth IRA and 401K at the same time?


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Safe Harbor 401k Plan

Safe Harbor 401k Plan

A safe harbor 401k plan is a unique type of retirement plan with two significant differences from a traditional 401k plan.  One, it requires mandatory employer contributions to employee accounts.  Second, it gives an employer an ability to offer a 401k plan to employees without any required discrimination testing.

The Safe Harbor 401k plan permits eligible employees to defer a portion of their salary to their own retirement plan account.  Employers then contribute to the participant’s account on behalf of eligible employees.  And, these employer contributions come in the form of either matching or non-elective amounts.

Safe Harbor 401k Plan Eligibility

Most any type of small business is eligible to establish and maintain a safe harbor 401k plan.  Sole proprietorships, LLC’s, partnerships, and corporations, including S corporations, are examples.

All eligible employees must be allowed to participate in the 401(k). An eligible employee is any one who:

  • is a minimum of 21 years old,
  • has performed one year of service and worked 1,000 hours in the year beginning with the date of hire.
  • Union employees and non-resident aliens without United States income may be excluded from participation in the plan.

One important thing to remember is that an employer may not establish more restrictive requirements than those listed above.  However, employers may set up less restrictive requirements for employee entrance into the safe harbor 401k plan.

Safe Harbor 401k Tax Benefits Tax Advantages

Employer contributions are tax deductible for the employer — up to 25% of compensation of all eligible participants.  Employee elective deferrals are excluded from the employee’s income for Federal Income Tax purposes.  Tax-deferred growth potential is possible — any investment earnings grow tax-deferred until withdrawn.

Vesting

Vesting refers to the participant’s ownership rights in the value of his or her retirement account.  Often, a traditional 401k plan required participants to wait a certain number of years before they can access the employer matching contributions. 

However, a safe harbor 401k is unique in comparison to other types of 401k plans in that all employee and employer safe harbor contributions are fully vested immediately.  There is no waiting period for employees to access the matching contributions made by employers.

Plan Deadline

Generally, the deadline to establish a new plan is anytime between January 1 and October 1 of the applicable year.

Contribution Flexibility

Under a safe-harbor plan, an employer can match each eligible employee’s contribution, dollar for dollar, up to 3% of the employee’s compensation, and 50 cents on the dollar for the employee’s contribution that exceeds 3 percent, but not over 5%, of the employee’s compensation.

Alternatively, employers may make a non-elective contribution equal to 3 percent of compensation to each eligible employee’s account. Non-elective contributions essentially means that contributions are made by employers to employee accounts regardless of employee contributions. 

Plan Compliance Issues

Because of the vested matching contributions required of the employer, the safe harbor 401k does not call for broad discrimination testing.  The safe harbor employer contributions stand in the place of discrimination testing.

Employee Benefits

  • Attracting and retaining key employees is easier with a 401k plan.
  • A 401k plan can help in providing retirement income for eligible employees.
  • Elected Roth contributions are allowed in safe harbor 401k plans.

Early Withdrawal Penalty

A 10% penalty is typically applied to all early distributions on safe harbor 401k plans, as well as traditional 401k plans.  Early distributions are distributions that occur before the age of 59½.