Tuesday, May 21, 2019
The average client who is not familiar with the detailed rules concerning the funding of 401(k)s and IRAs may believe that they are interchangeable. The Internal Revenue Service imposes restrictions on which clients are eligible to fund various types of accounts, and the rules vary both the plan contribution limits and the benefits associated with funding.
This year, eligible clients can contribute up to $6,000 to their IRA (an additional $1,000 for those 50 or older) and $19,000 to their 401(k) (with an additional $6,000 catch-up option). Then things can get a bit confusing. The “active participant” rules limit IRA contributions for taxpayers who have contributed to a 401(k) to those clients whose income has not exceeded certain thresholds. In 2019, IRA contributions are phased out for single taxpayers with modified adjusted gross income of between $64,000 and $74,000 and for joint returns between $103,000 to $123,000. If married and one spouse is an active participant, the threshold increase to between $193,000 and $203,000 for the other spouse.
Which account should be funded first? If an employer provides a matching 401(k) contribution, this should be thoroughly exploited to take advantage of the match. After that, many clients will consider diversifying between types of accounts to take advantage of a Roth feature, whether it be a Roth 401(k) option or Roth IRA, to provide for tax-free income during retirement.
Looking at the bigger picture and examining all relevant issues will serve to increase the odds that the client will maximize limited retirement savings dollars over the long-term.
See William H. Byrnes and Robert Bloink, Which Retirement Account Comes First, the 401(k) or the IRA?, Think Advisor, May 1, 2019.
Special thanks to Jim Hillhouse (Professional Legal Marketing (PLM, Inc.)) for bringing this article to my attention.