This is one of the most frequently asked questions I’ve been receiving lately both at work and via email. Companies across the country are trying to find ways to cut costs during this recession and a prime target is the matching program on a 401k or 403b. This is bad news for employees, but the silver lining is that cutting the match may reduce the need for cutting jobs. That might be a glass half-full way to think about it, but what if your match is taken away? Should you still contribute? Is a maximum 401k contribution worth it? Should you switch to an IRA? Or is it time to give up on retirement saving completely? There’s no easy answer that works for everyone. In some cases it may make sense to keep contributing while in others it might make sense to stop. So, let’s look at what you need to consider before making that decision.
Eligibility for IRAs
When it comes to saving for retirement, most people will utilize one of the two most common individual retirement accounts — the traditional and Roth IRA. Without getting into a lesson on the differences between a traditional IRA and Roth IRA, we’re going to work with the most notable difference in that a traditional IRA is funded with pre-tax dollars and qualified withdrawals are taxed, and the Roth IRA is funded with after-tax dollars and qualified withdrawals are tax-free. Before you give up on your 401k you need to make sure you’re eligible for contributing to an IRA. After all, if you’re ineligible to receive the tax benefits that IRAs provide, even without a match it would make sense to keep contributing to your 401k. Lean More: How to roll over your 401k into an IRA
Eligibility for a Roth IRA depends on your income. As a married couple you would qualify for a Roth IRA if your modified adjusted gross income (MAGI) is below $173,000. If MAGI is between $173,000 and $183,000, then you can contribute some, but not the full amount. If income exceeds $183,000, you do not qualify for any current year Roth IRA contributions. Single filers begin phasing out of a Roth IRA at $107,000 and is gone completely at $125,000. As you can see, depending on your income, giving up your 401k in favor of a Roth IRA may not even be an option. It’s a good idea to have a Roth IRA if you qualify, but just keep the income limits in mind before stopping your contributions with your current plan.
Here’s where things get a little more tricky. Unlike a Roth, a traditional IRA is funded with pre-tax dollars, so this type of retirement account closely matches your 401(k). If you were looking to mirror what you’re currently doing from a tax perspective, this is your likely candidate. That being said, the IRS doesn’t make it easy for us. There are also income limits and other considerations that need to be addressed before qualifying for tax-deductible contributions. The deductibility phase out for a traditional IRA for a single filer begins at $56,000 and ends at $66,000 if you’re currently covered under an employer-sponsored retirement plan. Joint filers phase out between $90,000 and $110,000. If married and your spouse is not covered by an employer plan, then there is no limit for you. I emphasized a piece of information above because there is often a lot of confusion as to what this means. Being covered by an employer-sponsored retirement plan has nothing to do with whether or not you’re contributing to a 401(k). Just because you elect not to doesn’t mean you’re not covered. As long as you have a plan and could contribute to it, as far as the IRS is concerned you’re still bound to the income limits. Furthermore, other pension and profit-sharing plans would also count. So even if your employer eliminated the 401(k) completely but still provided some sort of pension benefit, that’s considered being covered under an employer plan and subject to income limitations.
Other IRA Considerations
Finding out if you’re eligible for an IRA is the first step, so what’s the next step if you are? First, decide which type of IRA would be most beneficial for you. Are you single, no kids, and no major tax deductions? You may enjoy the continued benefits of deducting current contributions from your taxes with a traditional IRA. If you’re looking ahead to the future and expect your income to increase and tax rates to be higher, then a Roth IRA that gives you tax-free withdrawals in retirement may be your best bet. As long as you qualify, you could opt for an IRA of each type. To get started with your IRA, you have a few different options. First, you can open up an IRA with one of the big no-load fund companies such as Vanguard or Fidelity directly. Keep in mind that there may be a minimum investment requirement to get started. But this is a good way to invest directly in the low-cost funds you want.
The other option is to open your IRA with a discount brokerage company such as TradeKing. With a brokerage IRA you will have more flexibility in terms of investment options. Here you can buy individual stocks, bonds, ETFs, mutual funds, and even CDs all within the same account. If you’re looking to move beyond index funds with just one company, this can provide some flexibility as long as you keep transaction costs down, which TradeKing will do. Finally, don’t overlook the reduced IRA annual contribution limits. In 2009 you’re only allowed $5,000 ($6,000 if age 50+) per year in IRA contributions. If are currently putting more than this amount into your 401(k) you’d want to make sure you’re still contributing as much as you can. For example, if you have been contributing $10,000 to your 401(k) and want to switch to an IRA, you should max out your IRA with $5,000 and reduce your 401(k) contribution to $5,000. This way you’re still adding your $10,000 to your retirement accounts each year, but it’s simply divided across two accounts.
Some Final Considerations
A 401(k) without a match is still a viable retirement account, although the deal is obviously not as sweet without the free match money. If you’re considering the switch, be sure you take into account all aspects of the plan. While 401(k) plans get discussed in the news about high fees, remember that not all plans are created equal. Obviously, if you’re in a plan with high fees and you do qualify for an IRA, the decision is pretty simple. But there are a number of plans that may also have even better fees than you can get no your own. For example, my 401(k) plan has institutional variants of funds, including some Vanguard and Fidelity. That means after all said and done, my net expenses are the same or even lower on these funds than I could get in my own IRA. So, if your company drops the company match and you’re trying to decide what to do:
- Examine your current plan, check expenses and fund offerings, and see if the match has been temporarily suspended or eliminated indefinitely.
- Check to see what type of IRA you qualify for, and if eligible, decide whether a traditional or Roth is better for your situation.
- Open the necessary IRA through a no-load fund company or discount brokerage such as TradeKing.
- Make sure you’re still contributing the same amount or more to your retirement accounts even if this means contributing to both an IRA and your 401(k). Just because your company stopped matching doesn’t mean you should contribute less overall.
- Prepare for changes to your tax situation. Going from a 401(k) to a Roth IRA could have an impact on your taxes, so plan accordingly.
I hope that helps clear things up when faced with this question. As you can see, there are many reasons to switch to an IRA if your company drops the match, some of which I didn’t even touch on here. But there are also a number of limitations that need to be taken into account before making that decision as well. There may not be a right or wrong answer to this question, but if you’re armed with all the facts, you can make sure you’re making the most reasonable decision for your situation.
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About the Author: Jeremy Vohwinkle is a Chartered Retirement Planning Counselor® and spent a few years working as a financial planner. Today, he helps people make the most of their money by writing about personal finance here and elsewhere on the web. Jeremy is also Coach at Adaptu and a regular contributor for other publications such as Intuit, and American Express. Be sure to follow Jeremy on Twitter or Google+.