984. Laura answers a listener's question about the pros and cons of contributing to a Roth IRA in addition to a workplace retirement plan.
984. Laura answers a listener's question about the pros and cons of contributing to a Roth IRA in addition to a workplace retirement plan.
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Welcome back to Finance Friday, another special edition of Money Girl, where I answer your burning money questions! I love hearing from you; so, if something finance-related is on your mind, leave me a voicemail at 302-364-0308.
Today’s terrific question comes from Erica B., who says, “Thanks for your show! I’ve been listening for years and have learned so many wonderful tips on how to manage money and grow my wealth.
I’m 46 with three months’ worth of emergency savings and no debt other than my mortgage. I’m contributing 10% of my income to my 401(k) and receiving an additional 3% employer match. I keep hearing about the benefits of a Roth IRA. If I’m unable to max out the annual limit for my 401(k), what are the pros and cons of also contributing to a Roth IRA?”
Thanks for your excellent question, Erica, and congratulations on what you’ve achieved with your money! Having a healthy emergency fund, no consumer debt, and contributing a total of 13% of income to a retirement plan means you’re on a great financial path.
I love that Erica’s also considering the benefits of a Roth retirement account. This post will review who can contribute to a Roth IRA and the pros and cons of having one when you also contribute to a retirement plan at work.
Differences between traditional and Roth accounts
When choosing between traditional and Roth retirement accounts, it’s essential to understand the key differences, which mainly concern when you pay taxes and various contribution limits.
Any type of traditional account, such as an IRA or 401(k), allows you to make tax-deferred contributions. In other words, the funds you put in aren’t included in your taxable income for the year, which reduces your tax liability.
Your investment earnings in a traditional retirement account also grow tax-deferred. However, your withdrawals of contributions and earnings are taxed as ordinary income in retirement.
In addition, any withdrawals before age 59.5 are also subject to an additional 10% early withdrawal penalty, unless an exception applies. Once you reach 73, you must take required minimum distributions (RMDs) from traditional retirement accounts.
Roth accounts, such as a Roth IRA or 401(k), require nondeductible contributions–you make them with after-tax dollars. While a Roth doesn’t offer any upfront tax benefits, your withdrawals of contributions and earnings are tax-free after age 59.5, if you’ve owned the account for at least five years.
Roth accounts don’t have RMDs, and you can withdraw your original contributions any time without taxes or penalties. However, withdrawals of Roth earnings before age 59.5 are subject to taxes plus a 10% penalty, unless an exception applies.
In general, funding a traditional account is best when you need a tax break in the current year. It’s also beneficial if you believe your tax bracket or average tax rate will be lower in retirement than today. In that case, delaying taxes means you could pay less in the future than paying them now.
Since Roth accounts give you the opposite tax benefit, they’re a better choice when you believe you’ll be in a higher tax bracket or have a higher average tax rate in retirement than today.
However, if you’re unsure about your future tax situation or want to diversify, you can use both traditional and Roth accounts. Having tax-free Roth funds in retirement can give you peace of mind that you won’t have to share the balance with the government. In addition, as previously mentioned, you have the flexibility to tap original Roth contributions anytime without taxes or penalties.
Having tax diversification and tax-free withdrawals are likely the benefits Erica’s been hearing about. She didn’t mention whether her employer offers a Roth 401(k). If that’s an option, she could split her 10% contribution in any proportion between a traditional and Roth 401(k) at work. However, if her job doesn’t offer a Roth, she might be eligible for a Roth IRA.
LISTEN ALSO: Should I use extra cash for savings, investments, or debt?
How do you qualify for a Roth IRA?
Unlike other types of retirement accounts, a Roth IRA has income limits you must not exceed to qualify for contributions. The limit depends on your tax filing status and modified adjusted gross income (MAGI) as follows:
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.
Be aware that Roth IRAs have a unique rule that you must own the account for five years before qualifying to withdraw earnings penalty-free, no matter your age. Therefore, if Erica qualifies for a Roth IRA, I recommend that she open one sooner rather than later, even to make a small contribution that starts the five-year clock.
If you wait until you’re older to open a Roth IRA, you could get into a situation where you must pay tax on the earnings portion of a distribution because you still need to satisfy the five-year ownership requirement.
How much can you contribute to a Roth IRA?
For 2025, the contribution limit for either a Roth or traditional IRA is equal to your (or your spouse's) earned income up to $7,000 or $8,000 if you're over 50. For 2026, those limits will increase to $7,500 or $8,600 if you’re over 50.
If you want to contribute to both a traditional and Roth IRA, you can split them in any proportion as long as you don’t exceed the annual contribution limit. For example, if you’re under 50 in 2025, you could contribute $3,000 to a traditional IRA and $4,000 to a Roth IRA (if you qualify for one).
RELATED: When should I do Roth conversions?
Should you prioritize a traditional 401(k) or a Roth IRA?
If you want to reduce your taxes sooner rather than later, a traditional IRA or 401(k) is an excellent choice. If you’re like Erica and have a workplace plan with employer matching, prioritize maxing out the match before contributing to an IRA. Those free matching funds are valuable for boosting your account balance!
For instance, Erica gets a 3% match, which I’ll assume is a full match. If she earns $100,000 and contributes 3% ($3,000), her employer would also contribute $3,000. If she plans to contribute 10%, she could contribute the remaining 7% ($7,000) to a Roth IRA.
You can contribute to a traditional 401(k) and a Roth IRA in the same year if you don't exceed each account’s annual limit. For 2025, you can contribute up to $23,500 to a workplace retirement plan. The limit will increase to $24,500 in 2026.
If you’re over 50, you can contribute additional catch-up contributions of $7,500 in 2025 or $8,000 in 2026. Or, if you’re 60, 61, 62, or 63, you qualify for super catch-up contributions of $11,250 in 2025 and 2026. The good news is that you can exceed those thresholds with matching funds, which aren’t included in annual limits!
Unlike a Roth IRA, there are no income limits to qualify for a workplace Roth. So, if you don't mind paying taxes in the current year or want as much tax-free income in retirement as possible, then a Roth IRA or Roth workplace plan has many advantages.
READ ALSO: 7 pros and cons of investing in a 401(k) retirement plan
The upsides of contributing to a 401(k) and a Roth IRA
Unless Erica has a high tax bill that she’s trying to lower, I recommend contributing to both traditional and Roth accounts. If possible, she might use a Roth 401(k) to keep all her funds in the same employer account.
However, the upside of opening a Roth IRA is that she’d start the five-year ownership clock now. Plus, she could aim to max out both her 401(k) and Roth IRA for a total of $33,100 in 2026 if she’s under 50. That breaks down to a base contribution of $24,500 to her 401(k) plus $8,600 to a Roth IRA.
Using both traditional and Roth accounts gives you a mix of taxable and tax-free income in retirement. That gives you the ability to better manage your taxable income once you start taking account distributions. For instance, you could withdraw enough from a traditional account to stay in a lower tax bracket and then take Roth distributions to avoid additional tax.
LISTEN ALSO: Maxing out a 401(k) and IRA–rules, limits, and tax benefits explained
10 Ways a Roth 401(k) differs from a Roth IRA
If you’re unsure whether to use a Roth 401(k) or a Roth IRA, consider these ten differences.
1. Eligibility rules.
You can only have a Roth at work if your employer offers it. But anyone with earned income below the annual allowable limits (including minors and seniors) can have a Roth IRA.
2. Spousal benefits.
A key feature of traditional and Roth IRAs is that you qualify even if you don't have income, provided you file taxes jointly with a spouse. You could be unemployed, a stay-at-home parent, or run your own part-time business.
3. Contribution limits.
I reviewed the annual contribution limits, which vary significantly between a 401(k) and an IRA. You can stash away much more in a Roth 401(k) than in a Roth IRA.
4. Employer matching.
In addition to high contribution limits, many workplace retirement plans offer matching funds to incentivize participation. Note that matching funds are always pre-tax, so they get deposited into a traditional account on your behalf.
5. Income limits.
There are no income limits you must satisfy to participate in a Roth at work. However, for a Roth IRA, single taxpayers must have a MAGI of $150,000 or less for 2025 or $153,000 or less for 2026. Married taxpayers filing jointly must have a MAGI of less than $236,000 for 2025 or $242,000 for 2026.
6. Investment options.
Another difference between IRAs and workplace retirement plans is your menu of available investments.
7. Early withdrawals.
The rules for taking early withdrawals are similar for Roth workplace retirement plans and Roth IRAs. For both, withdrawals are tax-free if you’re 59.5 and have owned the account for at least five years. Otherwise, distributions of earnings will be subject to taxes and a 10% early withdrawal penalty, unless an exception applies.
8. Taking loans.
With either a traditional or Roth IRA, no loans are allowed; however, some employer plans may offer retirement account loans. Most 401(k) and 403(b) plans allow you to borrow up to 50% of your vested account balance, up to $50,000. However, you must repay yourself with interest within five years; otherwise, the outstanding balance is taxed as an early withdrawal.
9. Required minimum distributions (RMDs).
With a Roth at work and a Roth IRA, there are no RMDs.
10. Retiring early.
An IRS provision known as the rule of 55 allows workers who leave their jobs for any reason to take penalty-free distributions from their retirement accounts starting at age 55, rather than 59.5. However, that rule doesn't apply to traditional or Roth IRAs.
To sum up my answer for Erica, I recommend contributing enough to fully take advantage of her employer’s match. She can do that by contributing to her traditional 401(k) or, if offered, a Roth 401(k). In that case, she could continue contributing 10% to her 401(k).
But if she doesn’t have a workplace Roth and qualifies for a Roth IRA, she should open one on her own and contribute 7% of her income, or any amount she likes, up to the annual contribution limit. As I mentioned, opening a Roth IRA is wise even if you already have a Roth at work, so you can start and satisfy its five-year holding period sooner rather than later.
Remember that you can call in with a question, too–you’ll find the phone number in the show notes.
That's all for now. I'll talk to you soon. Until then, here's to living a richer life!
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