Why Having a Roth IRA and 401(k) Makes Sense

Assuming you are under the income threshold and thus are able, contributing to a Roth IRA in addition to your 401(k) might be a great idea. You begin being phased out of a Roth contribution at $118,000 for a single filer and are ineligible at $133,00, For married couples filing jointly the phase out begins at $186,000 and they are ineligible at $196,000. You can contribute up to a maximum of $5,500 under 50 and $6,500 over 50, assuming your income doesn't exceed the amount listed above in 2017.

Including a Roth IRA Means More Tax-Deferred Growth

So you can get the tax deductions for your 401(k) contributions, you should contribute at least up to your employer match (assuming there is a match), before funding a Roth. You should contribute at least up to the employer match because that is “free money” and is a 50% or 100% return, depending on the matching—no advisor is going to beat that. Then if you can afford it, keep contributing up to the maximum allowed, which is $18,000 plus a $6,000 catch-up provision if you are over 50. These 401(k) contributions will be deductible on your tax return.

Then you can make a Roth IRA contribution if you are under the income limits stated above. This will provide more tax-deferred growth for retirement while paying less taxes on the income and growth of your investments, thus maximizing your compounding effect.

Control Taxes Better—Now and in Retirement

Later, you will be able to better control your taxes in retirement. This is because distributions from a Roth IRA are tax free when you retire. So you can access monies from your Roth instead of taking more distributions out of your 401(k), which will likely have been rolled into a rollover IRA upon retirement. At 70.5, you will have to take taxable minimum required distributions (MRDs) from your rollover IRA or 401(k), but you won’t have to take out more for living expenses because you can access the Roth. In other words, you can manage and control the distributions from both accounts to minimize taxes.

Accessing Roth IRA Money for Emergencies

The other beautiful thing about the Roth is that you can access money from the Roth for emergencies or necessities tax and penalty free if you meet the proper requirements. These requirement are:

You can take out your own contributions at any time from a Roth, but if you take out any earnings, you will pay income tax and possibly penalties if not held for five years. The five years begins January 1 of the tax year of the contribution. So, if you made a contribution before April 17 (not April 15 due to the weekend), your five years starts ticking on Jan 1, 2016, so you get a 13-month "bonus." (For related reading, see: How to Use Your Roth IRA as an Emergency Fund.)

If you take out earnings before five years and are under 59.5, you will have to pay taxes and penalties. There are certain exemptions to avoid the penalties like education, disability, first home payment up to $10,000 and unreimbursed medical expenses. 

So as long as you are over 59.5 and have surpassed five years on your investments, there are never penalties. And again, you can always take out contributions anytime without taxes or penalties. So if you make it to 59.5 and have met the five-year rule, there are no taxes. This is what makes the Roth so flexible and lets you control your cash flow while managing your taxes. (For related reading, see: Roth IRAs: Distributions.)

Here is Charles Schwab's info about Roth IRA withdrawals. It is one of the best, most succinct explanations I have seen.

I will say this, one big mistake many people make is that they are so worried about the tax deduction or tax-deferred growth, they put all of their investable savings into retirement plans, including Roths, with hardly anything on the outside in taxable accounts. Then, when they want to purchase real estate or invest in something not offered in their retirement plans, they are paralyzed. A good rule of thumb is to have approximately 30% on the outside and 70% in your retirement plans in to be flexible. 

Lastly, when it is time to take distributions from 401(k)s or IRAs (not Roths) in retirement, you should usually roll your 401(k) assets directly into a rollover IRA. First, it gives you more control over distributions and withholdings, especially setting the withholding percentage you want withheld. But you also have almost limitless investment choices in a rollover IRA versus the limited choices inside your 401(k).

But combining a Roth IRA with “traditional” retirement plans will provide you more flexibility and control.

(For more from this author, see: Five Questions to Ask About Your Company's 401(k) Plan.)