Can they contribute to t401k AND open a Roth IRA?

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songman52
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Can they contribute to t401k AND open a Roth IRA?

Post by songman52 » Mon Dec 02, 2019 4:24 pm

Hi all. I would like some validation and some clarification. I searched the threads briefly but found no answer, so here goes.
One of my adult children asked me the other day, "How much is too much in checking?" It turns out that in addition to the current 401k (which will soon be rolled over to an existing IRA due to new employment), this child has approximately 20K in checking and about 40K in regular savings accounts. With their new job they will be contributing to a new 401k.

I suggested that this child fund the current IRA up to the maximum limit for 2019. They could then open a Roth IRA up to income limits, correct? The 2019 income is approximately $38K gross. The new job (which began today, Dec. 2) will be about 40K gross annually. Since the money is sitting in checking and savings accounts taxes have already been paid, so they should be able to just deposit the appropriate amount in a Roth IRA, yes? BTW the IRA comprises rollovers from previous 401ks from previous employers, and the IRA is in a Vanguard target fund. This 'child' is now 35 years old. What are the limits to what they can put in a Roth IRA for 2019 and for 2020?

Please confirm if my information is correct and educate me if not. We appreciate all of the help!
As to the child's question my answer was, "That seems too much." They can easily keep nine to twelve months of expenses in a combination of checking, savings, and other accounts such as CDs. That would be about 15K total.

Topic Author
songman52
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Re: Can they contribute to t401k AND open a Roth IRA?

Post by songman52 » Mon Dec 02, 2019 4:27 pm

I meant to indicate that the IRA is a traditional one, tax-deferred, from previous 401k rollovers.

Anon1234
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Re: Can they contribute to t401k AND open a Roth IRA?

Post by Anon1234 » Mon Dec 02, 2019 4:44 pm

Yes, s/he can.

Your child can contribute to both the traditional 401k and the IRA/Roth IRA in the same year. based on their income, I would choose the Roth IRA over the traditional IRA, especially since they already have contributed to a traditional 401k.

Total contributions to IRA and Roth IRA are limited to $6000 for 2019. ($7000 for those 50 and over). Contribution limits do not include rollover amounts.

Katietsu
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Re: Can they contribute to t401k AND open a Roth IRA?

Post by Katietsu » Mon Dec 02, 2019 4:55 pm

To make it completely clear:
Traditional IRA contribution + Roth IRA contribution must equal or less than $6000.

If they put $6000 in a traditional IRA then they can not add to the Roth for that year.

They can also put it all in Roth and not traditional. Or they can split it up with some in each, for example, $2000 in traditional and $4000 in Roth.

Since they are in a low tax bracket, I would lean towards the Roth. The other advantage of a Roth in their situation is that the contribution amount can be withdrawn tax free if a true emergency comes up. They should keep records of all their Roth contributions in order to complete their taxes if that situation would occur somewhere down the line.

ExitStageLeft
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Re: Can they contribute to t401k AND open a Roth IRA?

Post by ExitStageLeft » Mon Dec 02, 2019 4:55 pm

Congrats to your kid for being an great saver! They should at the very least put much of those savings in a high-yield savings account.

The limit for IRA contributions for 2019 is $6,000.
https://www.irs.gov/retirement-plans/pl ... ion-limits

They will not be able to make a contribution to a Roth IRA if their AGI is above $137k ($203k if married filing jointly). Otherwise they can contribute to a Roth IRA: https://www.irs.gov/retirement-plans/am ... e-for-2019

With a gross income of $40k, that means their taxable income is at most $28k. This puts them in the 12% federal tax bracket, which is a strong argument for putting as much retirement savings into Roth accounts as possible. I would discourage them from putting any funds into the tIRA this year.

lakpr
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Re: Can they contribute to t401k AND open a Roth IRA?

Post by lakpr » Mon Dec 02, 2019 5:08 pm

songman52 wrote:
Mon Dec 02, 2019 4:24 pm
I suggested that this child fund the current IRA up to the maximum limit for 2019. They could then open a Roth IRA up to income limits, correct?
This sentence does not quite make sense to me. For a person less than 50 years of age as of January 1, 2019 -- one can contribute $6000 in total to Roth IRA and Traditional IRA combined. You can split it as $4000 to traditional IRA and $2000 to Roth IRA, $3000 each to Traditional IRA and Roth IRA, etc. The point is that the $6000 is the COMBINED limit. Not a $6000 for traditional IRA and another $6000 for Roth IRA.
songman52 wrote:
Mon Dec 02, 2019 4:24 pm
The 2019 income is approximately $38K gross. The new job (which began today, Dec. 2) will be about 40K gross annually.
You need earned income to contribute to Roth IRA. For 2019 it's a slam dunk, but for 2020, I suggest that your child wait until they have actually earned $6000 in income before contributing to the Roth IRA for 2020. At a $40k per year job, that means your child will have to wait until about March (4 paychecks required) before contributing to Roth IRA for 2020.

With a $38K gross income for the year, and a standard deduction of $12.2k for a single person in 2019 (assuming your child is not married yet), he/she would fall into the 12% bracket. At this bracket, I suggest that your child contribute to Roth IRA. The money they are rolling over to the traditional IRA from the previous job to a traditional IRA, I suggest that they *CONVERT* that money to Roth IRA as well. Use the money that's currently in their checking and savings accounts to pay for the taxes to the IRS.

The 12% bracket is going to disappear once 2026 rolls around. The base tax rate will increase to 15%, if, as written into the law right now, the current personal tax rates sunset at the end of 2025. It is therefore likely that, when your child retires in another 30 years, they will be in a tax bracket that has a high probability of being higher than 12%.

Therefore, for 2020
- Your adult child elects to contribute to ROTH 401k in the new job
- Your adult child calls the IRA custodian and asks to CONVERT the money to Roth IRA. After this is done, your child should send the estimated tax payment to IRA of 12% of the amount converted. If that's $10k converted in total, he should pay $1200 to the IRS. Follow instructions in the link below (ignore the language about being self-employed and businesses etc., that's the same address he has to send estimated payments to)

https://www.irs.gov/newsroom/heres-how- ... ated-taxes

Roth conversions spike the quarterly income, and IRS requires that the taxes due to IRS be paid in substantially equal installments throughout the year. With a Roth conversion this late in the year, the taxes due must reach IRS by January 15th.

I suspect that the money that's earning 1% to 2% in your child's checking and savings account is best used this way. All future growth in the Roth IRA is tax free, the only stipulation he/she has to abide by is to not touch it until age 59.5.

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Wiggums
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Re: Can they contribute to t401k AND open a Roth IRA?

Post by Wiggums » Mon Dec 02, 2019 5:17 pm

lakpr wrote:
Mon Dec 02, 2019 5:08 pm
songman52 wrote:
Mon Dec 02, 2019 4:24 pm
I suggested that this child fund the current IRA up to the maximum limit for 2019. They could then open a Roth IRA up to income limits, correct?
This sentence does not quite make sense to me. For a person less than 50 years of age as of January 1, 2019 -- one can contribute $6000 in total to Roth IRA and Traditional IRA combined. You can split it as $4000 to traditional IRA and $2000 to Roth IRA, $3000 each to Traditional IRA and Roth IRA, etc. The point is that the $6000 is the COMBINED limit. Not a $6000 for traditional IRA and another $6000 for Roth IRA.
songman52 wrote:
Mon Dec 02, 2019 4:24 pm
The 2019 income is approximately $38K gross. The new job (which began today, Dec. 2) will be about 40K gross annually.
You need earned income to contribute to Roth IRA. For 2019 it's a slam dunk, but for 2020, I suggest that your child wait until they have actually earned $6000 in income before contributing to the Roth IRA for 2020. At a $40k per year job, that means your child will have to wait until about March (4 paychecks required) before contributing to Roth IRA for 2020.

With a $38K gross income for the year, and a standard deduction of $12.2k for a single person in 2019 (assuming your child is not married yet), he/she would fall into the 12% bracket. At this bracket, I suggest that your child contribute to Roth IRA. The money they are rolling over to the traditional IRA from the previous job to a traditional IRA, I suggest that they *CONVERT* that money to Roth IRA as well. Use the money that's currently in their checking and savings accounts to pay for the taxes to the IRS.

The 12% bracket is going to disappear once 2026 rolls around. The base tax rate will increase to 15%, if, as written into the law right now, the current personal tax rates sunset at the end of 2025. It is therefore likely that, when your child retires in another 30 years, they will be in a tax bracket that has a high probability of being higher than 12%.

Therefore, for 2020
- Your adult child elects to contribute to ROTH 401k in the new job
- Your adult child calls the IRA custodian and asks to CONVERT the money to Roth IRA. After this is done, your child should send the estimated tax payment to IRA of 12% of the amount converted. If that's $10k converted in total, he should pay $1200 to the IRS. Follow instructions in the link below (ignore the language about being self-employed and businesses etc., that's the same address he has to send estimated payments to)

https://www.irs.gov/newsroom/heres-how- ... ated-taxes

Roth conversions spike the quarterly income, and IRS requires that the taxes due to IRS be paid in substantially equal installments throughout the year. With a Roth conversion this late in the year, the taxes due must reach IRS by January 15th.

I suspect that the money that's earning 1% to 2% in your child's checking and savings account is best used this way. All future growth in the Roth IRA is tax free, the only stipulation he/she has to abide by is to not touch it until age 59.5.
I agree.

KlangFool
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Re: Can they contribute to t401k AND open a Roth IRA?

Post by KlangFool » Mon Dec 02, 2019 5:24 pm

OP,

Before you go down that road, please confirm whether they can qualify for either tax credits.

https://www.bogleheads.org/wiki/Saver%27s_credit

https://www.irs.gov/credits-deductions/ ... tax-credit

KlangFool

lakpr
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Re: Can they contribute to t401k AND open a Roth IRA?

Post by lakpr » Mon Dec 02, 2019 5:28 pm

KlangFool wrote:
Mon Dec 02, 2019 5:24 pm
OP,

Before you go down that road, please confirm whether they can qualify for either tax credits.

https://www.bogleheads.org/wiki/Saver%27s_credit

https://www.irs.gov/credits-deductions/ ... tax-credit

KlangFool
With a $40k income, they do qualify for a saver's credit of 10%, that would be $600; but that credit is available even if they contribute to Roth IRA. To qualify for the 50% tax credit, they'd have to save $20k combined in the traditional 401k and traditional IRA, that's 50% of their annual income. I suspect it might be a little unreachable.

Can't say about the EITC ...

KlangFool
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Re: Can they contribute to t401k AND open a Roth IRA?

Post by KlangFool » Mon Dec 02, 2019 5:43 pm

lakpr wrote:
Mon Dec 02, 2019 5:28 pm
KlangFool wrote:
Mon Dec 02, 2019 5:24 pm
OP,

Before you go down that road, please confirm whether they can qualify for either tax credits.

https://www.bogleheads.org/wiki/Saver%27s_credit

https://www.irs.gov/credits-deductions/ ... tax-credit

KlangFool
With a $40k income, they do qualify for a saver's credit of 10%, that would be $600; but that credit is available even if they contribute to Roth IRA. To qualify for the 50% tax credit, they'd have to save $20k combined in the traditional 401k and traditional IRA, that's 50% of their annual income. I suspect it might be a little unreachable.

Can't say about the EITC ...
lakpr,

It is entirely possible for someone with 60K in cash.

<<this child has approximately 20K in checking and about 40K in regular savings accounts.>>

KlangFool

Topic Author
songman52
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Re: Can they contribute to t401k AND open a Roth IRA?

Post by songman52 » Tue Dec 03, 2019 5:31 pm

Thanks to those of you who replied. Sorry if some of the post was confusing. I got the clarification I needed. She does not make contributions to the IRA. It is funded by rollovers from previous 401ks after changing jobs. She CAN contribute to it if she desires.

As I understand it, for 2019 she can contribute up to $6,000 in the IRA, or in a Roth IRA, or split it between the two. The amounts she has put in the 401k with her now previous employer have no bearing on this. Incidentally she will roll that 401k over to the IRA in due time. I don't believe contributions in a 401k with the new employer will begin until after the first of the year, based on soonest eligibility.

She could additionally open a regular taxable investment account with some of the remaining funds. As a single person she has been way over the EITC limits for several years but has gotten some of the Saver's credits. A contribution into a Roth IRA, together with whatever her 2019 401k contributions have been will reduce her AGI and help toward getting some of the Saver's Credit.
We will explore the tax impact before she makes any contributions.

Do I have this correct? I hope it's not still confusing. I sincerely appreciate all of the responses. :beer

lakpr
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Re: Can they contribute to t401k AND open a Roth IRA?

Post by lakpr » Tue Dec 03, 2019 5:58 pm

@songman2,

I think you got it right, but there's one other thing that I, and Klangfool, are suggesting.

==================================
My suggestion
With a 40k salary, as a single, your child is right at the top of the 12% bracket.
That 12% bracket is going to disappear in 2026, so I am suggesting that your child contribute the maximum allowed from her salary to the 401k plan, and contribute as a Roth 401k contribution. In addition, also contribute $6k to a Roth IRA

Thus, in 2020, your child will be able to shelter $25.5k per year into these accounts.
But you have $60k cash that's not already in an IRA. Have your child draw the living expenses from this $60k stash.

Klangfool's suggestion
You defer the maximum $19.5k in the 401k and an additional $6k to a Traditional IRA
This should drop your child's salary to $40k - $25.5k = $14.5k for the year
With that low a salary, your child will get 50% of the IRA contribution from the government as Saver's credit, and perhaps also qualify for EITC.

But you have $60k cash that's not already in an IRA. Have your child draw the living expenses from this $60k stash.
==================================
The main difference between my suggestion and Klangfool's suggestion is that -- KF believes your child will be, in retirement, in a lower tax bracket than now. Or at least, even if in a higher tax bracket, the refundable tax credits given by the government will reduce that sting to a great extent (the government is paying you!). I believe, on the other hand, after 2026 we will not ever see the 12% bracket again, so make-hay-while-the-sun-shines, drop everything into Roth accounts now with no taxes to pay in retirement. But the cost is that you have to pay 12% of the amount you are sheltering in the Roth accounts as tax to the government, now. 12% of 25.5k = $3200.

KlangFool
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Re: Can they contribute to t401k AND open a Roth IRA?

Post by KlangFool » Tue Dec 03, 2019 7:21 pm

lakpr wrote:
Tue Dec 03, 2019 5:58 pm

I believe, on the other hand, after 2026 we will not ever see the 12% bracket again, so make-hay-while-the-sun-shines, drop everything into Roth accounts now with no taxes to pay in retirement.
lakpr,

I disagreed. I believe that the income tax rate will drop and replace by sales/consumption taxes. And, I have the global trend among the Western Democracies to back this theory. The USA will be among the last countries to do this.

KlangFool

lakpr
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Re: Can they contribute to t401k AND open a Roth IRA?

Post by lakpr » Tue Dec 03, 2019 10:28 pm

KlangFool wrote:
Tue Dec 03, 2019 7:21 pm
lakpr wrote:
Tue Dec 03, 2019 5:58 pm

I believe, on the other hand, after 2026 we will not ever see the 12% bracket again, so make-hay-while-the-sun-shines, drop everything into Roth accounts now with no taxes to pay in retirement.
lakpr,

I disagreed. I believe that the income tax rate will drop and replace by sales/consumption taxes. And, I have the global trend among the Western Democracies to back this theory. The USA will be among the last countries to do this.

KlangFool
Noted. It is up to the @songman52 to believe which of our competing theories is correct and adopt the suggested follow up actions. I have an existing law to back up my position, the 12% bracket WILL sunset in 2025, reverts to 15% bracket on the same income. I don't have to gaze into the crystal ball. You just have a hunch.

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teen persuasion
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Re: Can they contribute to t401k AND open a Roth IRA?

Post by teen persuasion » Wed Dec 04, 2019 8:22 am

lakpr wrote:
Mon Dec 02, 2019 5:28 pm
KlangFool wrote:
Mon Dec 02, 2019 5:24 pm
OP,

Before you go down that road, please confirm whether they can qualify for either tax credits.

https://www.bogleheads.org/wiki/Saver%27s_credit

https://www.irs.gov/credits-deductions/ ... tax-credit

KlangFool
With a $40k income, they do qualify for a saver's credit of 10%, that would be $600; but that credit is available even if they contribute to Roth IRA. To qualify for the 50% tax credit, they'd have to save $20k combined in the traditional 401k and traditional IRA, that's 50% of their annual income. I suspect it might be a little unreachable.

Can't say about the EITC ...
Saver's credit is only on the first $2k of contributions, so at 10% that's a max of $200.

As a single with zero children (none mentioned), they would be phased out of EITC. EITC tests on both w2 wages AND AGI (have to be eligible on both tests, and get the lower credit), so only 401k contributions are useful for increasing EITC. IRA contributions only change AGI, not w2 wages.

ETA: Saver's credit is non refundable, it can only offset tax owed. EITC is fully refundable, but doesn't appear reachable unless the person has at least one child.

lakpr
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Re: Can they contribute to t401k AND open a Roth IRA?

Post by lakpr » Wed Dec 04, 2019 8:39 am

teen persuasion wrote:
Wed Dec 04, 2019 8:22 am
Saver's credit is only on the first $2k of contributions, so at 10% that's a max of $200.

As a single with zero children (none mentioned), they would be phased out of EITC. EITC tests on both w2 wages AND AGI (have to be eligible on both tests, and get the lower credit), so only 401k contributions are useful for increasing EITC. IRA contributions only change AGI, not w2 wages.

ETA: Saver's credit is non refundable, it can only offset tax owed. EITC is fully refundable, but doesn't appear reachable unless the person has at least one child.
Thanks for this post, teen persuasion! Given this information that the Saver's credit is max $200, and EITC is un-reachable, my earlier recommendation to @songman52 stands -- his child is better off contribution to both Roth 401(k) and Roth IRA, and draw her living expenses from the $60k cash fund accumulated in the past.

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teen persuasion
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Re: Can they contribute to t401k AND open a Roth IRA?

Post by teen persuasion » Wed Dec 04, 2019 9:07 am

lakpr wrote:
Wed Dec 04, 2019 8:39 am
teen persuasion wrote:
Wed Dec 04, 2019 8:22 am
Saver's credit is only on the first $2k of contributions, so at 10% that's a max of $200.

As a single with zero children (none mentioned), they would be phased out of EITC. EITC tests on both w2 wages AND AGI (have to be eligible on both tests, and get the lower credit), so only 401k contributions are useful for increasing EITC. IRA contributions only change AGI, not w2 wages.

ETA: Saver's credit is non refundable, it can only offset tax owed. EITC is fully refundable, but doesn't appear reachable unless the person has at least one child.
Thanks for this post, teen persuasion! Given this information that the Saver's credit is max $200, and EITC is un-reachable, my earlier recommendation to @songman52 stands -- his child is better off contribution to both Roth 401(k) and Roth IRA, and draw her living expenses from the $60k cash fund accumulated in the past.
Actually, looking closer at the Saver's credit brackets for singles in the wiki link KlangFool provided, at $40k income with all Roth contributions they are not eligible at all. They'd have to contribute enough to traditional accounts to be below $32.5k to reach 10%.

As KlangFool stated, they could contribute enough to both IRA and 401k traditional to reach the 50% bracket (there appears to be an error in the wiki here - there's a gap between the income levels for 20% and 50%). Fifty percent would be a credit of $1k, but in reaching that AGI level, they owe less than $1k in tax, so some credit is wasted. If they contribute less to traditional, they drop to the 20% bracket, the credit is $400, but they now owe more than $400 tax! (This is my biggest pet peeve with this credit being nonrefundable.)

They don't need to go all traditional to reach zero tax, a small portion could go Roth (go all traditional for 401k, fine tune the Roth IRA after January to get it perfect when all the numbers are in). You can quantify the cost to go all Roth vs all traditional: figure the tax if all Roth (tax on full income) vs zero tax (what is the breakdown that get to traditional vs Roth). I'd guess about $3100 federal tax to go all Roth, given the figures stated.

KlangFool
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Re: Can they contribute to t401k AND open a Roth IRA?

Post by KlangFool » Wed Dec 04, 2019 9:35 am

teen persuasion wrote:
Wed Dec 04, 2019 8:22 am
lakpr wrote:
Mon Dec 02, 2019 5:28 pm
KlangFool wrote:
Mon Dec 02, 2019 5:24 pm
OP,

Before you go down that road, please confirm whether they can qualify for either tax credits.

https://www.bogleheads.org/wiki/Saver%27s_credit

https://www.irs.gov/credits-deductions/ ... tax-credit

KlangFool
With a $40k income, they do qualify for a saver's credit of 10%, that would be $600; but that credit is available even if they contribute to Roth IRA. To qualify for the 50% tax credit, they'd have to save $20k combined in the traditional 401k and traditional IRA, that's 50% of their annual income. I suspect it might be a little unreachable.

Can't say about the EITC ...
Saver's credit is only on the first $2k of contributions, so at 10% that's a max of $200.

As a single with zero children (none mentioned), they would be phased out of EITC. EITC tests on both w2 wages AND AGI (have to be eligible on both tests, and get the lower credit), so only 401k contributions are useful for increasing EITC. IRA contributions only change AGI, not w2 wages.

ETA: Saver's credit is non refundable, it can only offset tax owed. EITC is fully refundable, but doesn't appear reachable unless the person has at least one child.
Thank you for the additional information.

KlangFool

Topic Author
songman52
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Joined: Fri Feb 24, 2012 2:20 pm

Re: Can they contribute to t401k AND open a Roth IRA?

Post by songman52 » Wed Dec 04, 2019 1:21 pm

Thanks to all of you for the extensive replies. FYI the status is single, no kids, low expenses and a good saver. With all of the talk about $40k earnings, she certainly hopes to have salary increases in future years.

The saver's credit has been very low if anything and the EITC has not been in play for years. I believe her main concern is making better use of her savings and providing better for retirement.

For me, I have enjoyed reading your responses. Thank you.

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