IRAs, Roths, 401(k)s: when should you, and can you, choose each one?

Different types of plans make sense at different times. Photo by Keenan Loo via Unsplash.

We all know that planning for retirement is important in divorce, given that most workers no longer have access to pensions and Social Security will need to be adjusted in some way in order to sustain current and future workers.

General Rules for Retirement Accounts

Currently, retirement plans generally have similar rules, though the annual contribution limit may differ. You must have earned income, which includes salary/wages and alimony, in order to contribute. There are penalties to withdraw early, usually before age 59 ½, though there are some exceptions to this. One of them is when withdrawing money from an employer plan with a QDRO.

Both Individual Retirement Arrangements (IRAs) and employer-sponsored plans such as 401(k)s may come in either Traditional or Roth “flavors”.

Retirement accounts grow tax-deferred, so the growth is not reduced by paying taxes while the funds are accumulating. As noted in an earlier article, whether or not income taxes must be paid on withdrawals, and whether withdrawals must start at the age of 70 ½, usually depends on whether pre-tax or after-tax money was invested into the account.

When to use a Traditional (pre-tax) plan

Many workers expect to have lower income tax rates once they retire and are no longer working full-time. Here a Traditional account works well, especially if the individual is currently in a high tax bracket. Tax deductions are worth more to those in higher tax brackets, as they reduce taxable income, which is more valuable to higher earners. If there is no employer-sponsored retirement plan, contributions to a Traditional IRA are fully deductible. If a worker is covered by such a plan, then deductibility for an IRA is phased out above certain income limits.

When to use a Roth (after-tax) plan

By contrast, when money contributed is after-tax: either not deducted on the tax return or taken from the paycheck after taxes have been computed, the money can be withdrawn tax-free (as long as the account has been open five years and the account owner is at least age 59 ½). For a Roth IRA, there is no age 70 ½ withdrawal requirement since taxes have already been paid.

This type is a good option for those in a low tax bracket, often those who have just started their careers, or those who otherwise expect a higher tax bracket in retirement. The ability to contribute to a Roth IRA is phased out above a certain income level.

Having both types of accounts

For example, a divorcee might contribute to a Roth right after the divorce when her income is lower, and then contribute to a Traditional once her income rises and the tax deduction is more valuable. The Roth account can still be maintained, even when contributions to it have stopped.

Contribution limits

These are different for IRAs compared to employer sponsored retirement plans such as 401(k)s, 403(b)s, SIMPLE IRAs, and profit sharing plans. For an IRA, whether Traditional or Roth, annual contributions are capped at $5,500 per year, plus $1,000 “catch-up” provision if you’re over age 50 (for 2018; caps may rise over time).

Those with employer-sponsored plans can contribute significantly more. SIMPLE plans in 2018 are capped at $12,500 per year, plus $3,000 over 50 catch-up. The limit for the other plans such as 401(k) and 403(b) is $18,500 plus $6,000 catch-up in 2018, and caps can rise for employer-sponsored plans as well. SEP IRAs are limited by business income. Withdrawal restrictions on employer plans are similar to IRAs, though workers still employed at age 70 ½ do not have to take required distributions from the plan at the company where they are employed, subject to some company ownership caveats.

Interestingly, the limit for all contributions to employer-sponsored plans such as 401(k)s and 403(b)s in 2018 is $55,000 (plus $6,000 catch-up) as long as the worker earns at least $55,000. This includes employee plus employer contributions. Even so, these often do not add up to $55,000. Therefore, if the plan allows for it (the Summary Plan Description or SPD will specify if allowable) additional after-tax nonelective contributions can be made up to the $55,000. These contributions are separate from the $18,500 maximum. As an example, an under-50 worker can contribute $18,500 into a 401(k) and their employer contributes $11,500 (employer matches are pre-tax) for a total of $30,000. If the SPD allows, the employee can invest an additional $25,000 after-tax, which will grow tax-deferred.

Employer match

Some employers offer a match for their retirement plan, and their employees should do all they can to ensure that they contribute at least enough to capture the whole match.

If there is additional money to be saved, the employee can open up a Traditional or Roth IRA (subject to income limitations) and max that out as well.


Employer plans are best for setting aside money for retirement. Those not covered by a plan should max out their IRAs.Current (and future) tax brackets must be considered when deciding whether to contribute to a Roth or to a Traditional plan. Not all employers offer a Roth plan, so that decision may be made for you. It’s a needlessly complex system, but understanding it can help you make the most from your money after divorce.

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