Laura answers a listener's question about using a 401(k) and whether now is a good time to invest.
Laura answers a listener's question about using a 401(k) and whether now is a good time to invest.
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 Cassandra from Queens, New York, who says:
"I'm 56 years old and work for a NYC agency. I've had many good jobs in my lifetime, but I don't have a 401(k). However, I do have a NYC pension plan and an IRA. Do I need a 401(k), and is it wise to open one in this current political climate with so much market volatility? Thank you from a forever and grateful listener."
Cassandra, thank you so much for your question and for being part of the Money Girl community! I love that you're thinking about investing more for retirement. Regularly contributing to one or more tax-advantaged retirement accounts is wise if you want a financially comfortable retirement.
This post will review five types of retirement accounts, their rules and benefits, and who qualifies to use them.
Thanks for downloading episode 925 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.
5 types of retirement accounts
An important concept about retirement accounts is that they're not investments. They're terrific places to own various investments, so you get preferential tax treatment.
Consider a retirement account like your house or apartment. It shelters and protects you, but it isn't you. Similarly, a retirement account is a shelter that protects your investments from taxation while you own them inside the account. Different accounts offer different tax benefits, which we'll review.
Here are five retirement accounts you may be eligible for depending on your income and employment.
1. Traditional individual retirement account (IRA).
A traditional IRA is available to anyone at any age with earned income, including wages, salaries, commissions, taxable alimony, and self-employment income. For an IRA, some types of income are excluded, such as earnings and profits from real estate, interest income, and pension or annuity income.
Contributions you make to an IRA get allocated to your chosen investments. Depending on the investing firm's menu, you may be able to purchase stocks, exchange-traded funds (ETFs), mutual funds, index funds, certificates of deposit (CDs), and money market funds.
For 2025, you can contribute an amount equal to your (or your spouse's if you file taxes jointly) earned income up to $7,000. However, if you're over 50, you can contribute an additional $1,000 or $8,000.
The primary benefit of owning investments in a traditional IRA is that you don't pay tax on the money you put in the account. In other words, your contributions are tax-deductible. However, your future withdrawals of contributions and earnings are subject to your ordinary income tax rate at the time.
As your IRA investments grow, you only pay tax on the earnings once you withdraw them. You can begin taking penalty-free distributions after the official retirement age of 59.5. You must start taking required minimum distributions (RMDs) after age 73 (or 75 beginning in 2033).
If you tap a traditional IRA before 59.5, in most cases, you must pay income tax on the withdrawal, plus an additional 10% early withdrawal penalty. That's why I never recommend breaking open a traditional retirement piggy bank--it's too expensive!
RELATED: How to use a spousal IRA to boost your retirement
2. Roth IRA.
Unlike a traditional IRA, you can only contribute to a Roth IRA when you earn less than an annual threshold, which I'll review in a moment. If you qualify, you can make Roth IRA contributions with qualifying earned income, regardless of age.
For 2025, the contribution limit for a Roth IRA is the same as a traditional IRA. It's equal to your (or your spouse's) earned income up to $7,000 or $8,000 if you're over 50.
With a Roth, you make after-tax, non-deductible contributions and can make tax-free withdrawals in retirement. That could allow you to skip decades of account growth, saving massive taxes.
Additionally, there are no RMDs with a Roth IRA, as with a traditional IRA. Your Roth IRA funds can stay in the account and easily get passed to your heirs.
Another significant Roth IRA benefit is that it's less punitive for taking early withdrawals before age 59.5 compared to a traditional IRA. Since you pay tax upfront on Roth contributions, you can take them as penalty-free distributions anytime. However, withdrawals of earnings would be subject to taxes plus a 10% penalty if you're younger than 59.5.
Be aware that Roth IRAs have a rule that you must own the account for five years before qualifying to withdraw your earnings penalty-free, no matter your age. Therefore,
I recommend opening a Roth IRA sooner rather than later, even if you can only make a small contribution.
That ensures you'll never be in a situation where you must pay tax on the earnings portion of a Roth IRA distribution because you still need to satisfy the five-year ownership requirement.
Here are the 2025 income limits to qualify for a Roth IRA:
If you qualify to contribute to a Roth IRA but become ineligible in the future, you can keep your account indefinitely and enjoy its tax-free growth. However, you can only make new contributions if your income dips below the annual allowable limit.
You can open a traditional or Roth IRA at many banks, brokerages, and other financial institutions. It's managed by a custodian who invests your funds as you direct them and handles any necessary administrative work.
Cassandra didn’t mention her income or if she has a traditional or Roth IRA. I recommend that she max out a Roth IRA annually if she can. But if she earns too much, then maxing out a traditional IRA instead is a wise move.
READ ALSO: Is it better to have a traditional IRA or Roth IRA?
3. SEP-IRA.
If you have part- or full-time business income, in addition to qualifying for an IRA, you also qualify for retirement plans for the self-employed. One is a simplified employee pension or SEP. The investment vehicle it uses is an IRA, known as a SEP-IRA.
You can use a SEP-IRA if you're an employer or self-employed with no employees. You can have any business entity, such as a sole proprietor, partnership, LLC, or corporation.
A SEP-IRA is treated like a traditional IRA for tax purposes because you typically make tax-deductible contributions. Your money grows tax-deferred until retirement and then gets taxed when you take distributions. If you withdraw money before age 59.5, you're typically subject to a 10% early withdrawal penalty plus income tax.
If you have a business with employees, a critical rule of a SEP-IRA is that employees can never contribute their own money. Contributions can only come from the employer.
For 2025, you can make SEP-IRA contributions for each of your employees (including yourself) up to 25% of their compensation for a maximum of $70,000. You must offer a contribution rate that's the same for all your employees, including yourself.
In other words, if you create a SEP-IRA for yourself, you must set one up for each eligible employee and contribute the same percentage to their accounts. For example, if you draw a salary of $60,000 from your business and put 15% ($9,000) of your pay in a SEP-IRA, you also have to contribute 15% of each employee's pay to their account.
However, if you don't have a profitable year, you can stop contributions and resume them later if you wish. But you get a nice tax break for your generosity because contributions to your and your employees' SEP-IRAs are tax deductible.
It's easy to set up a SEP-IRA with a financial institution, brokerage firm, or investing platform. You can put contributions into various investments, like index, mutual, and exchange-traded funds.
READ ALSO: How does a SEP-IRA work?
4. Employer plans like a 401(k), 403(b), or 457.
Now, let's switch gears and talk about employer-sponsored retirement plans. Tens of millions of Americans participate in workplace retirement plans, which may be why Cassandra is wondering whether she needs one.
You can only enroll in a 401(k) or similar workplace retirement plan when your employer offers it. So, perhaps Cassandra never had a job that offered one, or she did but chose not to enroll in the plan at that time. Since Cassandra mentioned having an NYC pension, I'm guessing she works or used to work for the city and that's what was provided.
Workplace retirement plans allow employees to contribute a portion of their paycheck to various savings and investment options, such as CDs, mutual funds, index funds, and EFTs.
Traditional retirement accounts give you an immediate benefit by making contributions on a pre-tax basis, reducing your annual taxable income and tax liability. You defer paying income tax on contributions and account earnings until you take withdrawals in the future.
Or you might choose a Roth 401(k) if offered by your employer. With a Roth, you must pay tax upfront on your contributions; however, your future withdrawals of contributions and earnings are entirely tax-free.
A Roth 401(k) or 403(b) is similar to a Roth IRA; however, unlike a Roth IRA, they don't have annual income limits to qualify for contributions. That means even high earners can participate in a Roth at work or have one for their own business and reap the benefits.
Similar to IRAs, if you withdraw funds from a traditional employer-sponsored retirement plan before 59.5, you must pay income taxes and a 10% penalty. However, you typically have the option to take penalty-free withdrawals as early as 55 if you leave employment. In addition, some workplace retirement plans allow you to make hardship withdrawals or loans if you meet specific qualifications.
Note that if you (or a spouse) participate in a retirement plan at work, you can also max out a traditional or Roth IRA (if you qualify for one). However, depending on your income, some or all of your traditional IRA contributions may not be tax-deductible.
Cassandra, having a pension is a terrific benefit, but you can always invest in an IRA, up to the annual contributions limits, to boost your retirement income. Plus, you can invest any amount you like using a taxable brokerage account. It doesn’t offer tax benefits but it doesn’t require you to follow strict rules. In other words, you don’t necessarily need a retirement account to invest for retirement.
RELATED: 8 things to know about investing in a brokerage account
5. Solo 401(k).
I mentioned that you can only participate in a 401(k) when your employer offers one. If you're self-employed with no full-time employees except a spouse or business partner, you qualify for a solo 401(k). You can contribute as both an employer and employee of your business, increasing the annual contribution limit to one of the highest allowed for retirement plans.
For 2025, those with a regular 401(k) can contribute up to $23,500 or $31,000 if they're over 50. Your employer may make additional matching or profit-sharing contributions to your account, allowing you to exceed those limits.
If you have a solo 401(k), the annual contribution limits are much higher but depend on your business income. For 2025, the combined employer and employee contribution limit is up to $70,000 or $77,500 if you're over 50. If you're between 60 and 63, you qualify for an additional $11,250, for a total maximum solo 401(k) contribution of $81,250.
Note that if you have a regular 401(k) with another employer, you can also have a solo 401(k). However, the employee limits apply per person, not per plan. That means you can't exceed the employee limit of $23,500 or $31,000 if you're over 50 for 2025, no matter how many 401(k)s you have.
To summarize, anyone with qualifying earned income can have a traditional IRA; if you don't earn over an annual threshold, you're eligible for a Roth IRA. But you only qualify for a workplace retirement plan, such as a 401(k), 403(b), or 457, when it's offered by your employer.
If you're self-employed, you can have retirement plans designed for small businesses, including a SEP-IRA or a solo 401(k), depending on whether you work alone or hire employees. In addition, you can use multiple retirement accounts as long as you don't exceed the annual contribution limit.
LISTEN ALSO: 6 biggest mistakes investors make in volatile markets
Should you invest during market volatility?
Cassandra also asked about using a retirement account when the markets are volatile. The answer is that you should regularly invest for retirement no matter what’s happening in politics, the economy, or the financial markets.
The US economy and stock markets have repeatedly bounced back and exceeded
expectations after volatile periods. While past performance doesn't guarantee future success, the American economy is highly resilient.
Since 1980, the S&P 500–a stock market index tracking the performance of 500 leading US companies listed on exchanges–has dropped 5% or more in most calendar years and 10% or more in about half. Despite that volatility, the S&P 500's average return since 1980 has been about 12%!
Even the 2008 financial crisis, when stocks fell nearly 50%, was just a temporary setback for investors with a long-term outlook. However, if you have a short time horizon, such as nearing or being in retirement, you can mitigate risk by owning a larger percentage of bonds and cash and fewer stocks.
While it might feel unsettling to see the value of your portfolio go up and down, it's a normal part of investing for the long term. However, as I mentioned, if you need to spend funds in the short term, such as within two to three years, they should never be invested.
If you're unsure how to manage investments on your own or during volatility, consider using a robo-advisor or working with a certified financial planner or retirement advisor for customized advice.
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!
Money Girl is a Quick and Dirty Tips podcast, and I want to thank our fantastic team! Steve Riekeberg audio-engineers the show. Brannan Goetschius is our director of podcasts, Holly Hutchings is our digital operations specialist, Morgan Christianson is our advertising operations specialist, and Nathaniel Hoopes is our marketing contractor.