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Where's the Best Place for Extra Savings—a Roth 401(k) or Roth IRA?

Key Points
  • Contributing to both a Roth 401(k) and a Roth IRA is certainly possible—as long as you still fall within Roth IRA income limits.

  • Start by contributing up to the company match in your Roth 401(k), then make sure other financial essentials are covered.

  • Lucky enough to still have more to put toward retirement? Upping the percentage in your 401(k) can be the simplest choice.

Dear Carrie,

I'm 22 and recently started my first real job. I've had a Roth IRA for a couple years, saving what I could from my part-time jobs. Now I've also opened a Roth 401(k) through my new employer. I'm contributing up to the company match in that account, but I still have money left over at the end of the month. Should I increase my Roth 401(k) contribution or deposit my additional savings into my Roth IRA?

—A Reader

 

Dear Reader,

First, congratulations—not only for your new job, but also for your very clear thinking about retirement at such a young age. While I always encourage young people to begin saving for retirement as soon as possible, it's usually a hard sell.

As I often say, if you start in your 20s, save just 10-15 percent of your annual salary and continue to save consistently throughout your working years, you'll be pretty well set up for retirement. But even that isn't always convincing enough. So I give you a lot of credit for your early start, as well as your apparent commitment to saving even more.

Your question is a good one and, actually, raises a few more questions. The first one being not just if you should continue to contribute to your Roth IRA, but if you're still qualified to do so. And then, above and beyond retirement savings, there are some other smart money management moves that you should be focusing on early as well. Let's start with the Roth IRA.

Are you still within the income limits of a Roth IRA?

While there are no income limits to contribute to a Roth 401(k), there are income limits on who can contribute to a Roth IRA. While you were working part-time, you probably easily fell within those limits. But with your new full-time employment, it’s a good idea to double-check the figures.

For a single filer to contribute the full annual amount of $6,000 to a Roth IRA in 2019 (plus an additional $1,000 for those 50 or over), you have to be earning under $122,000 (or under $193,000 for married filing jointly). Contributions are phased out between $122,000 and $137,000 for single filers ($193,000-$203,000 for married filing jointly). Once you reach those upper limits you can no longer contribute. So before you decide where to put your extra savings, you have to determine if a Roth IRA is still a viable option for you.

Are you on top of your debt?

When it comes to smart money management, you have to prioritize. And right after contributing up to the company match in your employer's 401(k) comes paying off nondeductible, high interest debts like credit cards. If you're carrying credit card balances, before putting extra money toward retirement, I'd suggest you bring those balances down—ideally to zero.

Come up with a debt payment plan you can easily handle. For instance, pay more on the highest interest card first, while paying at least the minimum due on any others. When the first card is paid off, move down the list. Then once you're at zero, commit to staying there by charging only what you can afford to pay in full each month. Just think how much more you can save if you're not paying 17 or more percent in interest!

And for the record, paying down student debt shouldn't keep you from saving for retirement. Just make sure to never miss a payment.  

Do you have an emergency fund?

Next on your list of priorities is making sure you're covered in case the unexpected happens. It's a good idea to keep three to six months of essential living expenses easily accessible in something like an interest-bearing checking account to handle financial emergencies. You may want to save even more if you think you might be changing jobs within the next year or anticipate any other significant life events that might jeopardize steady earnings.

In addition, if you have a high deductible health plan, you can use a Health Savings Account to save and invest money to cover short and long term health care costs pre-tax, tax-deferred, and tax-free.  

Everything covered? Consider upping the percentage in your 401(k).

With your debts under control and your emergency fund established, it’s time to increase your retirement savings if you can. I'm a big believer in keeping things simple, so my first choice would be to add any extra money to your 401(k). That would make it easy to stay on top of your investments, which really is what a 401(k) is all about—not just saving, but investing. However, make sure you're happy with the investment choices your 401(k) offers and that account fees are low.

The limit for 401(k) contributions in 2019 is $19,000 (plus $6,000 for 50 or over). If you can save beyond that (which would be pretty spectacular), then you might consider adding to an IRA—either your Roth IRA if you still qualify or possibly a traditional IRA. One advantage of an IRA is that it gives you more control over your investment choices. And a traditional IRA could give you a bit of income tax diversification in terms of tax deductibility.

You've got this.

Again, I'm impressed with what you're doing. Keep it up. And be sure to tell your friends how you're saving for the future. If they follow your example today, they'll be thanking you for many years to come!

 

Have a personal finance question? Email us at askcarrie@schwab.com. Carrie cannot respond to questions directly, but your topic may be considered for a future article. For Schwab account questions and general inquiries, contact Schwab.

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The information provided here is for general informational purposes only and is not intended to be a substitute for specific individualized tax, legal or investment planning advice. Where specific advice is necessary or appropriate, consult with a qualified tax advisor, CPA, financial planner or investment manager. 

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