Laura answers a listener's question about the benefits of investing using a Roth retirement account.
Laura answers a listener's question about the benefits of investing using a Roth retirement account.
Money Girl is hosted by Laura Adams. A transcript is available at Simplecast.
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Welcome back to Finance Friday, another special edition of Money Girl, where I answer your burning money questions! Today's topic comes from Sami, who says:
“A friend told me that contributing to a Roth account means you end up retiring richer–is that true? Also, if I don’t have a retirement account at work, can you explain whether I should put money in a traditional or Roth IRA, a savings account, or a CD?”
Thanks for your great questions, Sami! Understanding retirement accounts and their benefits can be confusing. This post will review the benefits of using a Roth account at work or on your own. You’ll learn how they save you money, offer flexibility, and stack up against other types of financial accounts.
Thanks for downloading episode 919 of the Money Girl podcast! I'm Laura Adams, an award-winning author, money speaker, on-camera spokesperson, and founder of The Money Stack, a Substack newsletter. You can subscribe for free or become a paid member with access to live educational events!
You can learn more and connect with me at LauraDAdams.com. That's also where you can email your money question, learn more about my books and courses, and sign up for The Money Stack. You can also record a brief question or comment on our voicemail line at 302-364-0308.
When should you use a retirement account?
In general, you should have some amount of savings before you begin investing. Though we tend to use the terms saving and investing interchangeably, they're different.
Savings are for emergencies and significant purchases you want to make within a year or two. That money should never be invested because there's a risk its value could decline in the short term. Always keep your savings in an FDIC-insured bank, money market account, or CD to preserve it.
However, funds you need for longer-term goals three or more years in the future, such as buying a home, paying for a child's college, and, of course, retiring, should be invested. Yes, investing involves some risk, but without it, you aren't likely to earn enough growth to achieve significant goals like retiring.
There are several reasons why you should use a retirement account, such as an individual retirement account (IRA) or 401(k). Making pre-tax, traditional contributions cuts your taxes in the current year, saving you money.
For example, if you earn $60,000 and contribute $5,000 to a traditional IRA or workplace 401(k), you pay income tax on just $55,0000, not $60,000. When you retire and take distributions, that’s when you must pay income tax.
Roth retirement accounts, such as a Roth IRA or 401(k), have the opposite taxation of traditional accounts. Contributions to a Roth get taxed the year you make them. However, your future withdrawals are entirely tax-free.
If you invest for decades and your Roth account mushrooms in value, it's nice to know that you'll never have to pay income tax on your earnings. And if income tax rates increase down the road, that could make having a Roth especially sweet.
Retirement accounts allow you to select investments for your contributions, such as mutual funds and exchange-traded funds. They bundle hundreds or thousands of underlying securities, such as stocks, bonds, currencies, and real estate, which gives you diversification and reduced risk.
Your growth within a retirement account depends on your chosen investments but could be significantly higher than a high-yield savings account or certificate of deposit (CD).
For instance, an average annual return of 6% to 8% through investment funds is reasonable. You'd be hard-pressed to find a CD or bank account paying more than 4% right now.
If you saved $400 a month for 40 years in a bank savings account paying an average of 1%, you'd have slightly more than $235,000. But if you invested $400 a month for 40 years in a retirement account with funds paying an average of 7%, you'd have over $1 million.
With savings, you're not even keeping up with inflation, which is typically about 3% to 4%. You need investment growth to reach big financial goals like retirement. Otherwise, you aren't likely to end up with enough to have a comfortable lifestyle down the road.
READ ALSO: Is it better to have a traditional IRA or Roth IRA?
5 advantages of a Roth retirement account
Now that you understand why investing in tax-advantaged retirement accounts is critical for building long-term wealth, here are five advantages of using a Roth.
1. Having flexibility to withdraw contributions.
With traditional retirement accounts, you must reach age 59.5 before withdrawals are penalty-free. But with a Roth, you can withdraw your contributions at any time, tax- and penalty-free. That gives you a safety net for unexpected expenses, although it's generally best to leave your retirement savings untouched so it can grow.
However, if you withdraw any earnings before age 59.5, they’re typically subject to income taxes and an additional 10% early withdrawal penalty.
Having the flexibility to tap contributions is why a Roth is also an excellent choice for non-retirement goals such as paying for college, buying a home, or starting a business. However, a unique rule of using a Roth IRA is that your income can't exceed an annual threshold. Keep reading to learn more.
2. Not having income limits at work.
A workplace Roth and a Roth IRA are very similar; however, there are some significant differences to know. First, anyone with income can use a Roth IRA. But you can only have a Roth 401(k) or a Roth 403(b) if your employer offers it.
An often-overlooked benefit of having a Roth workplace plan or a Roth solo 401(k) is that there are no annual income limits to qualify. If you're eligible for a Roth 401(k) at work or have a Roth for the self-employed, you can contribute no matter how much money you make.
For 2025, here are the income limits to qualify for a Roth IRA:
RELATED: Think you’re too rich for a Roth? Think again
3. Having multiple retirement accounts.
Having a Roth IRA or a Roth at work is terrific—but don't stop there. You can easily pair them with other Roth or traditional accounts if you don't exceed the total annual contribution limits.
For 2025, you can contribute up to $23,500, or $31,000 if you're over age 50, to a workplace retirement plan. The annual contribution limit is lower for a traditional or Roth IRA: $7,000 or $8,000 if you're over 50.
For example, you can max out a Roth 401(k) at work and contribute the maximum to a Roth IRA or a traditional IRA. You can also split your contributions between traditional and Roth accounts in any proportion you like.
For instance, you could contribute $10,000 to a traditional 401(k) and $13,500 to a Roth 401(k). Or you could contribute $5,000 to a traditional IRA and $2,000 to a Roth IRA if you're under age 50 and don't earn too much for a Roth IRA.
Depending on your income, your tax deduction for a traditional IRA may get reduced or eliminated when you or a spouse also have a traditional workplace retirement plan. But no matter your income, you can still contribute to a traditional IRA.
With a Roth IRA, there's no conflict because your contributions are not tax-deductible. So, as long as you don't earn too much to contribute to a Roth IRA, you can max out both a Roth IRA and a workplace retirement plan every year and get 100% of the tax benefit.
4. Getting tax-free withdrawals in retirement.
When choosing which retirement account to use, the best strategy is to fund the one that will give you the best tax benefit. If you need a tax break in the current year, a traditional account will help. Otherwise, I recommend maxing out a Roth first.
With a Roth, you get the most potential future tax savings, which can make you richer in retirement. As I mentioned, Roth withdrawals of contributions and earnings are entirely tax-free, which could save you much more in the long run compared to a traditional account. Plus, you’ll have peace of mind that the money in your Roth account is 100% yours, with nothing owed to the government for income taxes, capital gains, dividends, or interest in your later years.
While you don't get an immediate tax deduction like with a traditional retirement account, paying taxes now can be advantageous if you anticipate being in a higher tax bracket in retirement. While no one knows what will happen with taxes, by locking in your tax rate today, you could save money down the road.
RELATED: How to use a mega backdoor Roth conversion
5. Creating advantages for your beneficiaries.
Roth accounts offer unique estate planning advantages because your beneficiaries receive them income tax-free. That makes them a terrific vehicle for passing tax-free wealth on to your heirs.
In addition, unlike traditional retirement accounts, Roths have no required minimum distributions (RMDs). That means you can withdraw any amount at any time you like.
Sami, to sum up, the earlier you begin investing in a Roth account, the richer you'll be in retirement. Having a tax-free income source is excellent for controlling your tax liability. But for short-term goals, like emergency funds or making a planned purchase in a couple of years, you should keep them completely safe in FDIC-insured savings or CDs.
Before we go, here's a quick reminder to subscribe to The Money Stack, my Substack newsletter, when you visit LauraDAdams.com. It's filled with money tips, tools, news, challenges, and things I enjoy! You can subscribe for free or become a paid member with access to live educational events.
That's all for now. I'll talk to you soon. Until then, here's to living a richer life!
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