Women's Money Wisdom

Episode 284: Roth IRAs & 401(k)s: The Tax-Free Growth Strategy You Might Be Overlooking

• Melissa Joy, CFP® • Season 4 • Episode 284

Share episode

Is the Roth the secret weapon of retirement planning?

Melissa Joy breaks down everything you really need to know about Roth IRAs and Roth 401(k)s—from how they work and who they’re best for, to why they’ve become a powerful tool for long-term financial freedom.

Whether you're early in your career or already eyeing retirement, understanding the pros and cons of Roth accounts can help you make smarter tax decisions and build wealth that grows—and comes out—tax-free.

Melissa covers:

  • ✅ Roth vs. Traditional contributions: what’s the difference?
  • 📊 Roth income limits, contribution caps, and how they’ve changed over time
  • 🔁 What a Roth conversion is (and when it makes sense)
  • 🚪 The “Backdoor” and “Mega Backdoor” Roth strategies
  • 👨‍👩‍👧‍👦 Why Roth accounts can be powerful legacy tools for your heirs
  • 🎯 How to build tax diversification into your retirement game plan

This episode clears up common misconceptions and explores the real value of Roths—not just as a savings option, but as a strategic move in your larger financial plan.

The previous presentation by PEARL PLANNING was intended for general information purposes only. No portion of the presentation serves as the receipt of, or as a substitute for, personalized investment advice from PEARL PLANNING or any other investment professional of your choosing. Different types of investments involve varying degrees of risk, and it should not be assumed that future performance of any specific investment or investment strategy, or any non-investment related or planning services, discussion or content, will be profitable, be suitable for your portfolio or individual situation, or prove successful. Neither PEARL PLANNING’s investment adviser registration status, nor any amount of prior experience or success, should be construed that a certain level of results or satisfaction will be achieved if PEARL PLANNING is engaged, or continues to be engaged, to provide investment advisory services. PEARL PLANNING is neither a law firm nor accounting firm, and no portion of its services should be construed as legal or accounting advice. No portion of the video content should be construed by a client or prospective client as a guarantee that he/she will experience a certain level of results if PEARL PLANNING is engaged, or continues to be engaged, to provide investment advisory services. A copy of PEARL PLANNING’s current written disclosure Brochure discussing our advisory services and fees is available upon request or at https:...

Speaker 1:

Welcome to the Women's Money Wisdom Podcast. I'm Melissa Joy, a certified financial planner and the founder of Pearl Planning. My goal is to help you streamline and organize your finances, navigate big money decisions with confidence and be strategic in order to grow your wealth. As a woman, you work hard for your money and I'm here to help you make the most of it. Now let's get into the show.

Speaker 1:

I bet most of you have heard about Roth IRAs or Roth 401ks, but you probably think maybe there's a little more to learn. This is something I should consider. I need to know a little bit more about this and I want to talk all about Roth today. I want to talk about the Roth IRA and 401k, how it is powerful and pros and cons of choosing Roth. So hopefully you have some more answers and know how to think about Roths in the future, especially as you review your retirement plans, look at where your options are to contribute things. So we're going to go into the history as well as advantages and disadvantages. So if you could choose to never pay taxes again on money that you have in an account, that sounds pretty good, right? That's the promise and the privilege of Roth and, of course, keep in mind like this is a tax advice. We aren't replacing your CPA or enrolled agent or tax professional, but we're going to just talk around the implications of where you choose to save. So and hopefully during this episode we can demystify kind of conversations about Roths, because you get a lot of like well-intended but kind of blanket advice from people over time about Roths. So just to get started, roth is Roth R-O-T-H because it was named after a senator.

Speaker 1:

Senator William Roth of Delaware created the Roth IRA or created legislation that resulted in the Roth IRA, and it started way back in 1997. And I remember back then I think the initial contribution amount was about $2,000 a year and of course a lot of inflation has happened since then, but the value of what you can put into Roth has grown or maybe kept pace with inflation over time. So they were much smaller back in the day. And then later in 2006, the Roth 401k was also introduced and while it had to be incorporated into plans initially, it's much more broadly available nowadays. So you get choices both in terms of where you put money into IRAs as well as where you put money into your 401ks in many cases, and this even can be possible with other types of retirement plans such as 403bs, which are often available for nonprofits and government entities. Roths were slow to gain adoption. They were, you know, a small amount of money, as we've discussed, and people really had to learn about them.

Speaker 1:

And I'm going to tackle the Roth IRA first. So when you are putting money into a Roth every year, there's an eligibility requirement that involves how much money you earned. So your AGI or Modified Adjusted Gross Income is taken into consideration when it's determined whether you would be eligible for a Roth contribution into your IRA, and that phases out around income of about $146,000. A single starts to phase it out and when you're married, income around $230,000. So for a large swath of Americans, you can make a Roth IRA contribution every year and in 2025, that contribution amount is $7,000. And it will change when you're over age 50 to be $1,000 more, so you can contribute $8,000 if over age 50. Now you can't do both an IRA and Roth IRA contribution. It's one or the other, but I will note that there's a big swatch of people who may make more money than they can get a tax break on their IRA. So if you make a smaller amount of money, which is under $79,000 if single and under $126,000. If you're married then you can deduct for an IRA contribution. But if you're over those thresholds but still able to make contributions to Roth, they're kind of one in the same, except for the growth.

Speaker 1:

In an IRA, while the money you put in is kind of tax-free, when you take it out, the growth in that money is not tax-free. So, roth, when you put the money in, you don't get any tax break on your tax bill. You just make a note that you put that money in and then down the road, when you take that money out, you also will not be getting a tax bill. So no break coming in but also no tax bill going out. So the money grows tax-free in the Roth IRA. When it comes to a traditional IRA, it just depends. But for people who are lower income, the IRA contribution will lower your taxes, whereas otherwise you may or may not get a tax break, or you may get a proportional tax break but not full, and then when you do end up taking the money out unless you've done something called tracking basis for the amounts that you didn't get a tax break on you'll pay a tax when you end up taking the money out.

Speaker 1:

Now the numbers get bigger. Keep in mind we were talking about $7,000 for 2025, and that number's indexed to inflation, so every year or two, the amount you're able to put in tends to go higher. In a 401k, you can put $23,500 into your 401k, and that's for 2025. There's higher even amounts for catch-ups, and you can choose in many cases to either do a traditional contribution, which would mean that you would lower your reportable income and thus have lower taxes, or do Roth contribution. Now, one thing that's noteworthy when it comes to your retirement plans and your 401ks, there's not an income threshold that kind of pushes you out from getting a tax break for that money, unless your plan doesn't have enough contributors or there's very few people participating. So you're going to get a tax break in most every case when you choose the traditional route, whereas you will have a higher tax bill, all things being equal, if you chose Roth instead of traditional, but then the rules mean that down the road, you won't be forced to take money out with a tax bill.

Speaker 1:

The Roth portion of your 401k, just like the Roth IRA, is tax-free upon distribution. So one of the things to think about just right off the bat is people really love to gravitate to Roths because they know that the tax calculation in the future is very simple you are not going to pay taxes on your Roth when you take the funds out. And some people have said, what if that got taken away? I think it would be very difficult to take away that tax benefit to money that's already in there. Perhaps things could be modified for future contributions, but unlikely to be kind of a change in regime for how things get calculated, be kind of a change in regime for how things get calculated.

Speaker 1:

But then on the flip side, many people are looking for ways to reduce or control for their taxes, and the traditional 401k contribution is one of the most rock solid ways for you to have an opportunity to reduce your current taxes. And so when you choose the Roth portion or the Roth choice, in essence you're giving up that opportunity to lower tax bill in a way that is very straightforward and can result in you know, for a married couple who are both working close to a reduction of $50,000 of reportable income, especially if you're in higher tax brackets. That can be really measurable in terms of amounts. So who should think about using traditional accounts versus Roth accounts? Like who would be a good candidate to use Roths. Well, if you hate taxes and you're just looking to lower future taxes, especially in retirement, that could be a great reason to put money into Roths.

Speaker 1:

Also, if you're earlier in your career, you're a young saver, maybe you aren't in the highest tax bracket yet. Maybe you're in the 12, 15, or 22 percent bracket. Then you know the advantage of getting that tax break is the smaller percentage of your income and maybe you're not as thirsty for that and you really love the opportunity to have many years compounding tax-free. Now, sometimes, though, when people have what hopefully we see in a lot of our listeners and our clients, you know your income changes over time and at one point taxes weren't as much of a concern, but now you just see that tax bill and as you make more money, you also owe more money in terms of taxes. There may be a point in time where you really want to start solving for current taxes. You really want to start solving for current taxes, and in that case I really encourage people. Unless they just have our wash in money and there's just always more money to save. It may make a big difference if you do that traditional 401k contribution, because that can lower the tax bill in a way that it's much more difficult to attain otherwise.

Speaker 1:

One of the things I encourage people to consider is that, even though people think in some cases and this is an opinion thing, it depends on your perspective that taxes may go up over time. Perhaps you're thinking you know we owe a lot of money as a country. Our debt and deficits need to be addressed. I think taxes are going higher over time. It not only matters what kind of the aggregate taxes are for the country, but what will your tax rate be when you get to the point in time that taxes come into play? So what are considerations for that? Well, we are actually able to forecast, based on current tax law, in our financial planning software where your taxes may be over time.

Speaker 1:

If you're someone who plans to retire earlier, maybe you plan to retire at age 59 and a half or at age 55, where you can retire and use your 401k for withdrawals without penalties from your last employer. Well, that may mean that you have additional opportunities to take money out of even a traditional account at a lower tax bracket. I know I'm getting a little in the weeds and this is a very personalized kind of calculation. It does depend on how tax regimes go over time, be more predictable that even if taxes go higher for the top earners, it may be more straightforward to say you could control for taxes in early retirement years before you get to considerations for retired distributions. So a lot to consider there.

Speaker 1:

Some people may choose to mix both the Roths and Traditionals. They may say, oh, I'm going to do 5% in Roth and 5% Traditional. That's totally okay. That consideration will be factored into your paycheck and you will get you know tax breaks if you ratchet up the Traditional and you'll pay a little more taxes now but pay less taxes in the future if you ramp up the Roth portion. You can also do what's called Roth conversions. So if you have IRA assets or 401k assets that you would like to turn into and they're traditional, you'd like to turn them into Roth then what you do is you pay a tax bill at the time of what's called the conversion, and so you might choose to take $10,000 and move it from your IRA to your Roth. This is a very popular strategy.

Speaker 1:

If someone has variable income let's say you're self-employed and or you work on commissions and some years are high and some years are low that could be a great time in those low years to consider converting or moving money over. Where you prepay your taxes now hopefully, or in some cases at a lower rate, and then you know that money can go tax-free. Roth conversions have you know additional rules for consideration. So it's something that you shouldn't just you know kind of shut your eyes and do you do need to make a plan for how to pay for that in taxes. But that is something we analyze all the time, especially toward the end of the year to see where a client stands in terms of their anticipated tax bill, see where their taxes may be in the future, because what they are either going to have an income, what they might have in distributions from retirement accounts, and then, if wise, there could be opportunities to take some money out at a lower tax bracket. Also, you could put in money over an amount. Well, you could do conversions of money that you'd already gotten no tax benefit from. So I mentioned that in traditional IRAs there's an income limit and after that your IRA contribution doesn't give you a tax break. Well, if you went and said I didn't get a tax break on an amount of money and you didn't have any other IRA assets, you could actually do what's called a tax-free conversion. That is often done for people who are over the income thresholds for Roths. It's commonly referred to as a backdoor Roth, and there's even a way to do this for some 401k plans not all, but some 401k plans have provisions for even more money than your $23,500 limit. That can be considered after-tax money, so no tax break, but that money, too, could be converted over to Roth. And if you want to look that up and Google it after listening to this episode, that is called the mega backdoor Roth conversion A lot to keep track of.

Speaker 1:

Now, going back to some of the other reasons that people may choose to have Roths or, to you know, carefully target the type of accounts that they have. If you're really focused on saving for generations, you know you'll have money left over at the end of your life and you want that money to go to heirs, who are people they're going to have a tax bill when they receive your 401k or your IRA. And if you pass away, based on current law, when you inherit an account like that, you have only 10 years to take the money out, so there's a restricted time period. It could even be five years. In some cases it could be shorter, but it's a lot of taxes in a short period of time, and so for those that are looking to really maximize generational wealth, paying taxes earlier may make sense, especially if you know that the people who receive your money will be in high tax brackets.

Speaker 1:

Conversely, if you're someone who plans to give most of your money to charities, or you're going to give half of your estate to charities and half of it to people, but you have about half and half of retirement accounts versus you know other assets like your house and financial accounts that are taxable brokerage accounts, then you could not have to worry about converting to Roth or contributing to Roth, because the nonprofit institutions don't end up paying taxes on those funds that they inherit, and then Roths can be very appealing for those that are going to be entering early retirement. You don't have a penalty. Let's say you retire at 50 and you religiously put money in for 10 years. Let's just keep the numbers even. Let's say you were only allowed to put in $7,000 into Roth for 10 years and there was $70,000 in it and it had grown over time, and maybe the overall account value was $70,000 in it and it had grown over time and maybe the overall account value was $140,000. So it had doubled. Well, if you had kept track of what you originally put in, in spite of being under age 59 and a half, you could take out the original contributions tax-free. So this is a great and important consideration if you need some flexibility on not having penalties for early retirement funds and can really be helpful.

Speaker 1:

So there's a lot to consider in terms of why you may or may not want to use these types of accounts and, you know, for people who just aren't sure where you're going to be in terms of tax regimes, then kind of hedging your bets and having some in tax deferred, some in Roth and also some in taxable accounts is a great way to have tax status diversification so that you can take from a little bit from every pot and have choices and control over taxes. If you ran into a very difficult tax regime, it may be that Roths are right for you at certain periods of time and not right for you in others. So, for example, you might have always put money into Roth accounts and then you just feel like money is tight now, but you were a great early saver. Maybe retirement is great, but I have so many client situations where life in the messy middle, with both parents that have extra needs as well as kids with growing costly habits, can result in, you know, kind of scaling back on certain savings or flipping so you have more money in your paycheck because you're getting a tax break on the way you put money in.

Speaker 1:

There are certain considerations on how to invest your Roth accounts as well. You might want to invest them if you kind of set up a game plan where your Roth accounts are going to be used later. You're marking those as legacy assets. You'll use them if you have to, but they would be great for your kids to inherit. Then you may want to be more aggressive in the way you invest and grow your Roth. But then again, if a Roth is an emergency reserve, you plan to use that money that you originally put in to help pay for your kid's college, a house down payment or early retirement. You may be more conservative. So again, there's no one-size-fits-all strategy.

Speaker 1:

Some people will just go up to you and say you got a Roth. That's the only way to do it and I encourage people to you know, listen to professional advice and listen to people who know your exact circumstances, because that can be really important in considering what is right for how to invest, how to save and, like I said, depending on both your personal circumstances as well as you know kind of general tax regimes it often depends. So, as you listen to this, if you're thinking, gosh, this has been interesting. First, I'd take a look, because people don't often even know what elections they've made when it comes to traditional versus Roth in their retirement plan. Second, there may be, if you're someone who has cash piling up and you're, like I'm, always looking for additional ways to save. You might be able to either bump up your retirement contribution, flip from traditional to Roth because that actually does stuff more after-tax money into plans, knowing that you don't have a future tax liability and or you may decide to start making Roth contributions or backdoor Roth contributions, depending on your income status.

Speaker 1:

It is a little more complicated than that. You can't do backdoor if you already had existing traditional IRA, so you know, read up on it before you just blindly start contributing, converting, but there's a lot of opportunities to consider. And then, if you're not taking taxes into consideration when it comes to a game plan for how things are going to look in retirement. If you're working with a professional that really doesn't talk to you about taxes on withdrawals or taxes over time, I encourage you to do some research or talk with a professional who does. There's a lot of us out there that are really taking these complicated multiple factors into consideration as we consider what is best for you now, both now and over time.

Speaker 1:

So hopefully you found that you learned something. You may have questions, because I know I dived into a topic that can be complicated. There's a lot of like asterisks and footnotes when it comes to explaining things like this. The numbers are constantly changing, whether it comes to the amount you can contribute as well as the amount that the income thresholds and things like that. So if you have any follow-up questions, need to dive further or would like to talk about considerations for Roths, please don't hesitate to reach out and with that, we'll be talking to you next week. Have a great week in the meantime.

Speaker 2:

Thank you for listening to the Women's Money Wisdom Podcast. If you found value in this episode, the best way that you can support the podcast is to forward an episode to a friend or leave a review. Go to proplancom and the podcast link to get all the resources and links mentioned. This presentation by Pro Planning is intended for general information purposes only. No portion of this presentation serves as a receipt of or a substitute for personal investment advice from Pearl Planning or any other investment professional of your choosing.

Speaker 2:

Copies of Pearl Planning's current rent and disclosure brochure and form CRS discussing our advisory services and fees are available upon request or on our website platform at pearlplancom. The information that we share is meant to educate and inspire, not serve as personalized financial advice. Everyone's situation is unique, so be sure to consult with your own financial professional for guidance that fits your life. And just so you know, the opinions shared in this podcast are Melissa's own and those of her guests. They don't necessarily represent any organizations with which Melissa is affiliated. For more important disclosures, please go to our webpage at proplancom.

People on this episode

Head Shot

Melissa Joy, CFP

Co-host