Is a Roth IRA worth it?

Key points

• A Roth IRA is funded with after-tax dollars, and withdrawals in retirement are tax-free.
• Income limits restrict who can contribute to a Roth IRA.
• A Roth IRA may not make sense for every investor.

There’s a saying in investing: Don’t let the tax tail wag the investment dog. In other words, don’t allow tax considerations to dictate your investment decisions. But when it comes to saving for retirement, understanding the tax advantages of different individual retirement accounts is important.

“The type of IRA you choose can have a significant impact on your long-term retirement savings and future financial goals,” said Andrew Crowell, financial advisor and vice chairman of wealth management at D.A. Davidson.

Traditional IRAs let you save pretax money and provide the immediate benefit of a tax deduction. Roth IRAs, on the other hand, are funded with after-tax dollars and can offer significant benefits over the long term.

What is a Roth IRA?

A Roth IRA is an individual retirement account funded with after-tax dollars. You don’t get an immediate tax break for your contributions like you do with a traditional IRA. In return, the IRS doesn’t tax qualified withdrawals.

“At its core, a Roth IRA strategy harnesses the power of compound interest,” said Will Rogers, a certified financial planner and private wealth advisor at Ameriprise Financial. “When money put in today remains invested and grows over time, you give the chance for your interest to earn interest.”

Since Roth IRA contributions are taxed on the way in, you don’t pay taxes on that compound growth.

This tax-free growth is one reason people sing the praises of Roth IRAs. But that doesn’t mean they’re right for every investor.

When you should consider opening a Roth IRA

While almost anyone can benefit from a Roth IRA, certain circumstances allow this retirement savings vehicle to really shine. Consider opening a Roth IRA if any of the following situations apply to you.

You’re a young worker

Roth IRAs are subject to income limits:

• If you earn $161,000 or more as a single filer or $240,000 or more as a married joint filer in 2024, you cannot contribute to a Roth IRA. 

• If you earn between $146,000 and $160,999.99 as a single filer or between $230,000 and $239,999.99 as a married joint filer in 2024, you can contribute a reduced amount to a Roth IRA.

Tip: For 2024, the total contributions you make to all of your traditional IRAs and Roth IRAs cannot exceed $7,000, or $8,000 if you’re 50 or older, subject to the above income restrictions.

When you start your career, your income may be lower, so the limits might not affect you.

You may also be in a lower tax bracket than you will be in retirement, meaning it might make sense to pay taxes on contributions now and withdraw funds tax-free in retirement.

You expect to be in a higher tax bracket in the future

Choosing between a Roth IRA and traditional IRA comes down to whether you want to pay taxes now or later.

Traditional IRAs offer upfront tax deductions, but you pay taxes on withdrawals in retirement. Thus, they are best suited for people who expect to be in a lower tax bracket in the future.

Roth IRAs, which allow you to make after-tax contributions, are best suited for people who expect to be in a higher tax bracket in the future, as qualified withdrawals are tax-free.

You want to leave a legacy

If you want to leave some of your retirement savings for a beneficiary, a Roth IRA may be the way to go. Withdrawals from an inherited Roth IRA are tax-free as long as the account is at least five years old.

You’re saving for multiple goals

You can withdraw your Roth IRA contributions anytime tax- and penalty-free because the IRS has already taxed that money. You can use the funds for any purpose, which is why some people use their Roth IRA as an emergency fund.

Note that withdrawals of Roth IRA earnings before you reach age 59½ and before the account is five years old may incur taxes and penalties.

You want to keep the money in your IRA past age 73

Since the IRS has already gotten its cut of the contributions, money in a Roth IRA is not subject to required minimum distributions. Many other retirement accounts require that you withdraw a certain amount of money annually beginning at age 73.

“This arrangement provides you with flexibility in retirement to withdraw money based on your lifestyle and expense needs instead of a set schedule,” Rogers said. “Funds are able to remain invested for longer periods of time, allowing the chance for additional investment growth through your retirement years.”

You want more income flexibility in retirement

Since distributions aren’t taxable, Roth IRAs can be a great source of tax-free income in retirement. Keeping your taxable income low in your golden years is key to remaining in a lower tax bracket while living your best life.

When a Roth IRA may not make sense

Despite the myriad benefits of Roth IRAs, they aren’t for everyone. Here are some situations where a Roth IRA may not make sense for you.

You expect to be in a lower tax bracket in the future 

Tax deductions today may be more beneficial than tax-free withdrawals later for people who pay a lot of income taxes. This is especially true if you expect to be in a lower tax bracket in retirement.

If you’re in a high tax bracket, chances are your income may preclude you from making direct Roth IRA contributions anyway.

You’re retired, and converting to a Roth IRA would result in additional costs

“Converting a traditional IRA to a Roth IRA may increase the amount of Social Security subject to income tax or possibly even what your Medicare premiums will be in two years,” Rogers said. “That’s because conversions are added to the tax calculation to determine how much of Social Security is taxable.”

Rogers provided an example of a retiree whose income is low enough that she doesn’t owe taxes on her Social Security benefits. She converts $100,000 from a traditional IRA to a Roth IRA, thinking she’ll owe only the 12% federal income tax on the conversion. But this new income pushes her into the 24% tax bracket and causes her to owe taxes on her Social Security, “not to mention any state tax,” Rogers said.

You can’t afford to fund both a Roth IRA and your 401(k)

An employer-sponsored plan with a company match should be your first priority for retirement savings.

“Many companies offer to match a certain percentage of your contributions, such as 50% of your individual contribution up to 6% of your salary,” Crowell said. “Always contribute enough to that account first to take advantage of any company match offered. Not doing so is leaving ‘free’ money on the table.”

Alternatives to Roth IRAs

If a Roth IRA isn’t worth it for you, consider the following alternatives.

Traditional IRA

A traditional IRA is the obvious alternative to a Roth IRA. It has the same contribution limits as a Roth IRA but provides an immediate tax deduction as long as you meet the income requirements.

Whether you’re eligible for a full or partial deduction depends on your modified adjusted gross income, your filing status, and if you or your spouse is covered by a workplace retirement plan. 

401(k) or 403(b)

An employer-sponsored retirement plan like a 401(k) or 403(b) can be a great alternative to a Roth IRA. Crowell said you should think about starting here if your company offers a match.

Employer-sponsored plans have much higher contribution limits than IRAs — $23,000 in 2024, or $30,500 if you’re 50 or older — so they’re great places to build a nest egg.

Roth 401(k)

A Roth 401(k) is essentially the employer-sponsored version of a Roth IRA. It provides the best of both worlds, as you can contribute up to the 401(k) limit for the year and take tax-free withdrawals in retirement.

There are no income restrictions, so if you make too much to contribute to a Roth IRA, a Roth 401(k) may be the plan for you.

Your employer may match a portion of your Roth 401(k) contributions, Rogers said, “providing you with additional funds to help maximize your retirement savings.”

Is a Roth IRA worth it?

A Roth IRA, with its tax-free withdrawals in retirement, can be a powerful addition to your retirement plan. And since it isn’t subject to RMDs, you can leave the money in your account for as long as you’d like.

“This arrangement provides you with flexibility in retirement to withdraw money based on your lifestyle and expense needs instead of a set schedule,” Rogers said.

But many people require a combination of strategies — meaning different types of accounts — to reach their retirement goals. A financial advisor can provide you with the information you need to select the right retirement plan options for your situation. 

Frequently asked questions (FAQs)

What are the disadvantages of a Roth IRA?

The disadvantages of a Roth IRA include low contribution limits and income restrictions.

You also don’t get tax deductions for your contributions, meaning a Roth IRA does not decrease your taxable income in the year you contribute.

How does my money grow in a Roth IRA?

The money in your Roth IRA grows tax-free. This is the account’s greatest benefit.

For example, if you put $7,000 in your Roth IRA today and it grows to $70,000 by the time you retire in 40 years, you won’t owe income taxes on the $63,000 of growth.

Can you lose money in a Roth IRA?

You can lose money in a Roth IRA just like you can in any investment account. Your earnings are subject to the investments you choose, and the stock market can be volatile.

But the stock market historically has always risen over the long term. And any losses are only paper losses until you sell your investments. If your account loses value, the best strategy is often to do nothing until the stock market rebounds. Time and patience are your greatest allies when it comes to investing for retirement.