7 Simple Reasons to Invest in a Roth IRA or Roth 401(k)

Get the scoop on how tax reform affects retirement account choices and 7 ways a Roth IRA or at work gives you huge tax benefits, access to funds, and flexibility.

Laura Adams, MBA
10-minute read
Episode #530


Money Girl podcast listener Peter D. asks, “Now that Congress has enacted lower tax rates for most Americans, does this make a Roth 401k more attractive than a traditional 401k?” Thanks for this great question, Peter.

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Retirement accounts are the best places to save because they allow you to cut taxes on the investments you own inside them and build a bigger nest egg. Roth accounts deserve to be put on a pedestal because they come with more benefits than any other type of retirement account.

Problem is, Roth accounts are vastly underutilized and misunderstood. Many people tend to rely only on traditional accounts and may not realize the huge tax benefits, access to funds, and flexibility that come with a Roth IRA (Individual Retirement Arrangement) or an employer-sponsored Roth.

In this post, I’ll answer Peter’s question and explain the best reasons you should invest money in a Roth retirement account now.

Benefits of a Roth Retirement Account

  1. Tax-free Income in Retirement 
  2. Penalty-free Early Withdrawals 
  3. No Income Limit for Workplace Plans 
  4. Unlimited Investment Choices 
  5. Easily Paired with Other Retirement Accounts 
  6. Non-working Spouses Qualify 
  7. No Age Limit to Make Contributions

Here’s more information about each of these fantastic Roth benefits.

1. Tax-free Income in Retirement

There are several differences between traditional and Roth retirement accounts, but the major one is how the funds are taxed. In both a Roth IRA and a Roth at work—such as a Roth 401(k) and a Roth 403(b)—you pay income tax upfront on contributions, but owe no additional tax when you take withdrawals in retirement.

As your investments earn income and receive dividends, they’re never taxed. If your account mushrooms in value over many years, you get to keep every penny.

With traditional retirement accounts, taxation is the opposite: You don’t pay tax on contributions, but you do pay income tax on withdrawals in retirement.

Getting tax-free income from a Roth in retirement is an amazing benefit.

Getting tax-free income from a Roth in retirement is an amazing benefit. Having less taxable income can reduce the likelihood that you’ll have to pay tax on your Social Security benefits and even cut your Medicare premiums.

So, your current and future tax situation plays a huge role in whether you should use a traditional or Roth retirement account. You can pay income tax on contributions now (with a Roth), or pay tax in the future on amounts withdrawn (with a traditional account).

No one knows for sure what the future holds, but if you believe that you’ll earn more money during retirement than you do now, and therefore would be subject to higher tax rates in the future, paying tax at a lower rate now makes sense. If you’re young or just starting your career, it’s possible that your income and tax rate is lower now than it will be when you retire.

This gets at the heart of Peter’s question about whether reforms in the Tax Cuts and Jobs Act of 2017 should make us re-think retirement account choices. The answer is yes, the new law can make a Roth slightly more beneficial for many Americans who now pay less income tax.

I say “slightly” because a Roth is already loaded with financial goodies, so paying a few percent less in income tax doesn’t radically change the game. But the reform does tip the scales a bit more in favor of choosing a Roth, when in doubt.

Also remember that new income tax brackets and reduced rates only last until 2025. No one knows if they’ll stick or be changed again. If the federal deficit keeps growing, tax rates may need to go up to bridge the budget gap.

Nonetheless, there’s no harm jumping on the Roth train now or diversifying your retirement contributions to both a Roth and a traditional account. You can always start or stop contributions at any time if your financial situation changes.

See also: 15 IRA Rules You Should Know

2. Penalty-free early withdrawals

While tax-free withdrawals in retirement are fantastic, there are even more Roth benefits to cheer about. One is the ability to tap your contributions without getting slapped on the wrist with a penalty.

In general, taking a withdrawal from a retirement account before reaching age 59½ comes with taxes, plus an additional 10% early withdrawal penalty. But because you pay tax upfront on Roth contributions, you’re allowed to take them out without paying income tax or a penalty.

However, your investment growth in the account (the money your contributions earned) has not been taxed. So, withdrawing any amount of earnings before age 59½ would generally be subject to income tax plus a 10% penalty.

For example, if you contribute $10,000 to a Roth and it grows to a value of $15,000, you can always withdraw your original contributions of $10,000 without paying tax or a penalty. This gives you access to your money for any reason, making it much more flexible than a traditional IRA or traditional 401(k).

I don’t recommend withdrawing funds from a retirement account, but having more flexibility with a Roth means you could get to your money in a pinch.

Depending on how you want to use funds withdrawn from a Roth account, you may even be able to avoid the early withdrawal penalty on the earnings portion of your account. If you’re younger than 59½ and have owned a Roth for at least five years, you can spend Roth earnings penalty-free (but not tax free) to:

  • Pay higher education costs for you or a family member. 
  • Buy, build, or rebuild a property that will be a first home for you or a family member, for up to $10,000. (Even if you’ve owned a home before, you’re considered a first-timer if neither you nor your spouse have owned a primary residence within the last two years.) 
  • Pay medical bills that exceed 10% of your adjusted gross income. 
  • Health insurance premiums while you’re unemployed.

Roth retirement plans at work may allow even more flexibility for penalty-free “hardship” distributions of earnings for certain expenses, including funeral costs.

I don’t recommend withdrawing funds from a retirement account, but having more flexibility with a Roth means you could get to your money in a pinch.

See also: 5 Retirement Account Options When You're Self-Employed


About the Author

Laura Adams, MBA

Laura Adams received an MBA from the University of Florida. She's an award-winning personal finance author, speaker, and consumer advocate who is a frequent, trusted source for the national media. Money-Smart Solopreneur: A Personal Finance System for Freelancers, Entrepreneurs, and Side-Hustlers is her newest title. Laura's previous book, Debt-Free Blueprint: How to Get Out of Debt and Build a Financial Life You Love, was an Amazon #1 New Release. Do you have a money question? Call the Money Girl listener line at 302-364-0308. Your question could be featured on the show.