February ACap ReCap – Your Personal Finance Questions Answered
- Why should I invest in a Roth IRA when the 401k gives me a tax break?
I was recently asked this question from a client whose CPA advised her against funding her Roth IRA. I believe it is best to maximize both your 401k and your Roth IRA accounts; if it’s not financially possible to maximize both, then first maximize the Roth IRA and put any extra savings into your 401k (assuming no company match). Here is why: Your Roth IRA grows tax free, but your 401k is tax-deferred – that means you will have to pay tax on your withdrawals when you retire. The Roth IRA is very flexible. You can take out your contributions at any time without tax or penalty. However, you cannot withdraw funds (even your contributions) from your 401k without incurring a penalty and paying tax. Furthermore, the 401k has Required Minimum Distribution (RMD) rules once you reach 70.5 years of age which forces you to begin withdrawing money from your account even if you don’t need it. Another benefit of the Roth IRA is that it does not have RMD. It is always a good idea to have options when you retire. If all of your savings are in a 401k, you only have a tax-deferred account to withdraw from. If tax rates end up higher in the future than now, you will be at a disadvantage. However, if you have money in both a tax-free and a tax-deferred type account, you can selectively choose which account to withdraw from that will have the least tax consequence and benefit you the most at the time of withdrawal.
2. Can I borrow from my IRA?
Unfortunately, you cannot borrow from an IRA like you can with some 401k plans. Individual Retirement Accounts are earmarked for retirement and can only be treated as such. Some 401ks allow you to borrow from your account balance, but that option varies by employer. We recognize that circumstances arise when you need immediate cash to pay for unexpected expenses. For this reason, we always encourage our clients to maintain sufficient emergency cash reserves to cover unexpected expenses. To find out how much emergency funds to keep on hand, read our December ACap ReCap by clicking here.
3. If I leave my job mid-year, can I still maximize my 401k?
Yes. The maximum you can contribute to a 401k in 2013 is $17,500 (plus an additional $5,500 if you are over 50). You have the entire year to make your contribution – you can deposit $17,500 in January (if your paycheck is large enough), in December, or evenly throughout the year. One thing to keep in mind is your employer match. If your employer matches your contributions, you want to make sure you spread your contributions evenly throughout the year because when/if you don’t contribute, your company won’t contribute. IBM took a bold step this year and changed how they match their employees’ 401k contributions. Click here to read my article on IBM’s 401k changes
4. I have two 401ks, can I contribute to both?
This is a very good question. As mentioned in a previous question, the maximum you can contribute to a 401k in 2013 is $17,500. If you have two jobs and each one has a 401k plan, you can still only contribute a total of $17,500. This can happen if you leave a job before year-end. Assume you left your job in July having contributed $10,000 to your 401k and start a new job in the same month; you can only put $7,500 into your new 401k, not the entire $17,500. Hence, you can have many 401ks, but the maximum you can contribute into all of them is $17,500. If you are in such a situation, I would recommend you contribute to the 401k that has the highest match, then contribute to the next plan with a match.
Have a question or need advice on how to manage your retirement accounts? Contact ACap Asset Management at email@example.com or 818-272-8511.
Ara Oghoorian, CFA, CFP® is the president and founder of ACap Asset Management, Inc., a “Fee-Only” investment management firm located in Los Angeles, CA specializing in helping doctors and physicians make sound financial decisions. Visit us at www.acapam.com