Why you should consider opening a Roth IRA

Recently I went down a Roth IRA rabbit hole for some clients. I have always been a fan of the Roth IRA, for younger folks especially, but now there is this for the not so young. If you make over $150k, are 50 or older, and you are maxing out your 401k with catch-up contributions, then you should probably have a Roth IRA if you don’t already.

Let me explain. In case you didn’t know, this year a new law takes effect with regard to catch-up contributions. If you earned over $150k last year and you intend to make catch-up contributions to your 401k because you are 50 years old or older, then those catch-up contributions must be made after-tax (Roth style). For 2026, the contribution limit for an individual is $24,500. This can be made pre-tax or after-tax (if your plan allows). The catch-up for individuals over 50 is an additional $8,000 in 401k savings, and whether or not that can be pre-tax or after-tax depends on how much you made last year. Click here for a little more of the technical details of the changes and how they will work.

Before we dig deeper, here is a little more relevant background on Roth IRAs. There are a few different things that need to happen in order to make Roth distributions fully qualified (tax and penalty free). The first, is that you need to be at least 59 ½ years old when you distribute the earnings of the account. The contributions to a Roth IRA can be taken out at any time without tax or penalty. The second, is that the Roth IRA needs to have been open for at least 5 years prior to the distribution of account earnings. This five-year rule applies to both Roth IRA and Roth 401(k) accounts separately.

Which leads me to this. Most people will roll their assets from their employer plan into an IRA or Roth IRA of their choosing after they separate from service and/or retire. If you have Roth 401(k) money, you could roll that into a Roth IRA. If the Roth 401(k) was open for five years or more, the seasoning rule will travel to the new Roth IRA for the entire amount rolled over. However, if you did not have a Roth IRA open in your name before this, this rollover starts a new five-year rule for any earnings in this Roth IRA.

Here is an example. Say you retire at age 60 with $100k in a Roth 401(k) that had already met the five-year rule (you started contributing at age 55 or younger). If you roll that money into a Roth IRA, the $100k can be withdrawn at any time without tax. But, let’s say that $100k grows to $150k after three years in your Roth IRA. And now you want use that money to buy a vacation home. Only the $100k can be withdrawn without tax. If you withdraw the whole amount, the $50k of earnings could trigger taxes owed as your Roth IRA has not met the five-year rule yet.

Assuming you have some time before retirement, an easy fix could be for you to start a Roth IRA now. Even if you contribute or convert $1 to fund it, this will start the five-year clock for you and your Roth IRA. I have had a Roth for over 15 years now, and both of my children have had them since they started working.

A better example might be this. Suppose you have only two years’ worth of Roth 401(k) contributions at work before leaving your job. That money is not fully seasoned and could be subject to taxes upon withdrawal. However, if you already had a Roth IRA open for over five years, you can roll those funds into your Roth IRA, and now those rules will govern your funds making them fully qualified. This also includes any future earnings on the rolled over investments. The five-year worry is a non-issue.

There is a lot going on here and it can be confusing. The bottom line is that starting a Roth IRA today is probably beneficial for a lot of folks. Think about it like you are giving your future self a gift by reducing future complexities. Who doesn’t love rather easy fixes now for potential future problems? Of course, make sure you check with your own advisors, or feel free to reach out to me if you have any other questions.