18 Jan What kind of IRA can I use?

Q. I have a 401(k) at work. Can I also save in an IRA? If I can, which kind of IRA should I pick?
— Saver

A. It’s great that you want to save as much as you can, and depending on your situation, you can use an IRA for those savings.

Let’s first look at the rules for a Roth IRA.

Contributions are made with after-tax dollars — meaning you don’t get a tax deduction in the year of the contribution.

But as long as you have the account for more than five years and are over the age of 59 ½ when you take your distributions, those monies come out tax-free, said Michael Cocco, a certified financial planner with AXA Advisors in Nutley. You also have the ability to withdraw your principal contributions at any time without tax or penalty.

And with a Roth, you will never have to take Required Minimum Distributions (RMDs). 

Cocco said your 401(k) plan at work will not affect your ability to contribute to a Roth IRA, but your eligibility is determined by your adjusted gross income (AGI).

“For 2016 tax year, if you are single and your AGI will be less than $117,000, you can potentially contribute up to $5,500 maximum into a Roth IRA, regardless of your 401(k) contributions,” he said. “If your AGI is between $117,000 and $132,000, you could potentially make a partial Roth IRA contribution, so contact your tax advisor for calculations on that amount.”

Cocco said if you anticipate that your AGI is going to be more than $132,000, you will not be allowed to contribute at all to a Roth IRA. For 2016, if you file your taxes married filing jointly, your combined AGI must be lower than $184,000 to fully fund a Roth, and the phase out starts at $184,000 and ends at $194,000.

A traditional IRA is different. Anyone can contribute, even if they have the ability to contribute to a 401(k) plan at work. The issue, though, becomes if you are allowed to deduct that IRA contribution from your taxes. That’s because traditional IRAs can potentially be funded with pre-tax dollars, but then they are fully taxable upon withdrawal, Cocco said.

“If either you or your spouse is covered by an employer’s retirement plan — for example a 401(k) plan, profit-sharing plan, defined benefit plan, Simple IRA, etc.– you may not be able to deduct some or any of your contributions,” Cocco said.

If you’re not sure which of where you land income-wise, speak to a tax preparer before you make your contribution.

“Another consideration is avoiding an excess contribution penalty — 6 percent on the excess contribution — which can happen if you defer more than is allowed based on your income,” said Anthony Vignier, a certified financial planner and attorney with Vignier Investment Group in Kearny.

So the kind of IRA that’s best for you will depend on your specific circumstances.

Cocco said he believes if your current income is on the lower-end of the spectrum of what you think it may be over the course of your lifetime, you should select the Roth IRA — assuming you qualify — because the benefit of the potential tax deduction from a traditional IRA may not be as great in comparison to the tax-free a0ccess of principal and earnings available through the Roth IRA over the long-term.

If you are a high income-earner and are not eligible to contribute to a Roth IRA, you can plan to contribute to a traditional IRA — and not take the tax deduction — with the possibility of converting to a Roth IRA in the future, Cocco said.

“When you decide to convert to a Roth IRA, you just pay tax on the earnings you have accumulated at the time of the conversion,” he said. “In any event, ensure that you contribute enough to your 401(k) plan to take advantage of any matching employer contributions offered to you, as I always like to call it, `free money.'”

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This story was first posted in January 2016.