- If you're covered by an employer's retirement plan, which includes a 401(k) plan, you must meet IRS-mandated income requirements to make a tax-deductible IRA contribution. For 2009, your modified adjusted gross income (AGI) must be under $55,000 for a single taxpayer and $89,000 for couples filing jointly or $10,000 for a married person filing a separate return to make a full contribution. The tax-deductible contribution you can make proportionately phases out as your income rises, and you lose the tax deduction entirely when your modified AGI reaches $69,000 (single) and $109,000 (married, filing jointly). There are no income restrictions on pre-tax contributions to a 401(k) account. By the way, any tax-deductible Traditional IRA contributions you make will lower the amount of contribution you can make to a Roth IRA. More on that later.
- The most you can contribute to an IRA in 2009 is $5,000. If you're older than 50, you can contribute another $1,000. You can contribute as much as $16,500 to a 401(k) plan and an additional $5,500 if you're older than 50. The IRS reviews its limits each year. But there's another consideration: Many 401(k) plans limit your contributions to a percentage of your salary. For example, if the plan limit is 10 percent, and you earn $40,000 a year, the maximum contribution your plan would allow is $4,000.
- If your company's 401(k) plan offers matching contributions from your employer, it would add value to your contributions in that plan. Matching 401(k) contributions are not taxable until you withdraw the money.
- Traditional IRAs offer a range of investment options, including real estate and commodities as well as stocks, bonds, mutual funds and bank products, such as CDs and savings accounts. In a 401(k), you can invest only in those options, often a dozen or fewer mutual funds, offered by the plan.
- Any withdrawals from either an IRA or a 401(k) before you turn 59½--besides some exceptions covered in IRS Publication 590 (see Resources)--will incur a 10 percent tax penalty and be taxed as ordinary income. After 59½, IRA withdrawals are taxed as ordinary income. If you have not started taking distributions when you reach 70½, you must take required minimum distributions. Generally, you cannot take monthly or annual withdrawals from a 401(k) plan. You must cash out completely, roll it over to an IRA or transfer it into a retirement annuity. Either option defers taxes until the year you receive a payout from your new account. One other consideration: Although you should only use it in a dire emergency, most 401(k) plans offer the option of loans from your account. Paying back the loan replenishes your account.
- If your modified AGI allows you to qualify for a tax-deductible IRA contribution, you also will qualify to make an after-tax Roth IRA contribution. The total limit for IRA contributions (Traditional and Roth) is $5,000 (plus the $1,000 catch-up contribution if you're over 50). Even if your contribution to the Roth is smaller because you won't get the immediate tax deduction, Roth IRAs have advantages over Traditional ones: your Roth account is effectively bigger because it contains only after-tax dollars. You can withdraw your contributions tax-free at any time and the earnings tax-free after you turn 59½ years. You can make full Roth IRA contributions even if you make a maximum contribution to your 401(k) as long as your modified AGI is less than $159,000 for couples filing jointly and $101,000 for single taxpayers.
- You can build a case for choosing to contribute to any of the available tax-deferred retirement options. But most personal finance advice follows this order of priorities:
1. Company-sponsored 401(k) with matching funds
2. Roth IRA
3. Company-sponsored 401(k) after/without matching funds
4. Traditional IRA
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