As an adult, getting your finances in order is confusing. Between the complicated names, trying to understand what is taxed and what’s not, and all of the unspoken rules, it’s a lot for one person to figure out on their own.
If you’ve heard the term Roth IRA floating around recently, it’s not just you. More people are electing to introduce one into their financial future and for good reason.
1. What’s the difference between a Roth IRA and a 401(k)?
First, it’s important to understand the difference between a Roth account and your typical 401(k). When you deposit money into your 401(k), add pre-tax funds from your paycheck, which is a good way to avoid paying more taxes on your income than is necessary. However, once you retire you still need to pay taxes on the money you’ve collected once you start withdrawing and using it.
With a Roth IRA, however, you pay taxes on the money you deposit before it goes into the account. That may seem like a bummer at first, but listen to this: that means that once it comes time to retire, your money has already been taxed and you won’t have to pay taxes on it down the line the way you do with your 401(k)
2. How are Roth IRAs helpful?
If you’re still not sure why when you pay taxes on this money, there are a couple of things to consider. First, you have to think about tax brackets and the amount people are taxes based on the income they bring home. When you start making more money years from now (presuming that you grow in your field and work your way up the chain), your income could increase but so could the amount of taxes you pay on the money you bring home. If you think you’re likely to be earing a lot more in the future-and taxed more accordingly-contributing extra money to your Roth account might be ideal.
In other scenarios, you might get to a point where you are able to max out your 401(k), or contribute enough per year that you are not legally allowed to contribute any more. Even under those circumstances, you might still want to keep saving for retirement, and opening up a Roth account to which to contribute can help you do so.
A Roth IRA is by no means a requirement for those saving for retirement. However, if you want to diversify your savings or contribute more than what 401(k) limits allow, set up an account to continue maximizing your savings for the future.