Dec
12
2025
Solo 401(k) vs SEP IRA: Key Differences and Considerations

Solo 401(k) vs SEP IRA: An In-Depth Comparison for Self-Employed Retirement Planning

By | Growing Wealth, invest, Investing | Comments Off on Solo 401(k) vs SEP IRA: An In-Depth Comparison for Self-Employed Retirement Planning

Self-employment has its perks, but an employer-sponsored retirement plan isn’t one of them. Opening a solo 401(k) or a Simplified Employee Pension Individual Retirement Account (SEP IRA) allows the self-employed to save for retirement while enjoying some tax advantages.

So, which is better for you? The answer can depend largely on whether your business has employees or operates as a sole proprietorship and which plan yields more benefits, in terms of contribution limits and tax breaks.

Weighing the features of a solo 401(k) vs. SEP IRA can make it easier to decide which one is more suited to your retirement savings needs.

Key Points

•   Solo 401(k) allows tax-deductible contributions, employer contributions, employee contributions, and offers the option for Roth contributions and catch-up contributions.

•   SEP IRA allows tax-deductible contributions, employer contributions, but does not allow employee contributions, Roth contributions, catch-up contributions, or loans.

•   Withdrawals from traditional solo 401(k) plans and SEP IRAs are taxed in retirement.

•   Solo 401(k) plans allow loans, while SEP IRAs do not.

•   Solo 401(k) plans offer more flexibility and options compared to SEP IRAs.

Understanding the Basics

A solo 401(k) is similar to a traditional 401(k), in terms of annual contribution limits and tax treatment. A SEP IRA follows the same tax rules as traditional IRAs. SEP IRAs, however, typically allow a higher annual contribution limit than a regular IRA.

What Is a Solo 401(k)?

A solo 401(k) covers a business owner who has no employees or employs only their spouse. Simply, a Solo 401(k) allows you to save money for retirement from your self-employment or business income on a tax-advantaged basis.

These plans follow the same IRS rules and requirements as any other 401(k). There are specific solo 401(k) contribution limits to follow, along with rules regarding withdrawals and taxation. Regulations also govern when you can take a loan from a solo 401(k) plan.

A number of online brokerages offer solo 401(k) plans for self-employed individuals, including those who freelance or perform gig work. You can open a retirement account online and start investing, no employer other than yourself needed.

If you use a solo 401(k) to save for retirement, you’ll also need to follow some reporting requirements. Generally, the IRS requires solo 401(k) plan owners to file a Form 5500-EZ if it has $250,000 or more in assets at the end of the year.

What Is a SEP IRA?

A SEP IRA is another option to consider if you’re looking for retirement plans for the self-employed. This tax-advantaged plan is available to any size business, including sole proprietorships with no employees. SEP IRAs work much like traditional IRAs, with regard to the tax treatment of withdrawals. They do, however, allow you to contribute more money toward retirement each year above the standard traditional IRA contribution limit. That means you could enjoy a bigger tax break when it’s time to deduct contributions.

If you have employees, you can make retirement plan contributions to a SEP IRA on their behalf. SEP IRA contribution limits are, for the most part, the same for both employers and employees. If you’re interested in a SEP, you can set up an IRA for yourself or for yourself and your employees through an online brokerage.

💡 Quick Tip: Did you know that you must choose the investments in your IRA? Once you open a new IRA and start saving, you get to decide which mutual funds, ETFs, or other investments you want — it’s totally up to you.

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Diving Deeper: Pros and Cons of Each Plan

As you debate between a solo 401(k) vs. a SEP IRA as ways to build wealth for retirement, it’s helpful to learn more about how these plans work, including their benefits and drawbacks.

Advantages of Solo 401(k)s

In terms of differences, there are some things that set solo 401(k) plans apart from SEP IRAs.

With a solo 401(k), you can choose a traditional or Roth. You can deduct your contributions in the year you make them with a traditional solo 401(k), but you’ll pay taxes on your distributions in retirement. With a Roth solo 401(k) you pay taxes on your contributions in the year you make them, and in retirement, your distributions are tax free. You can choose the plan that gives you the best tax advantage.

Another benefit of a solo 401(k) is that those age 50 and older can make catch-up contributions to this plan. In addition, you may be able to take a loan from a solo 401(k) if the plan permits it.

Advantages of SEP IRAs

One of the benefits of a SEP IRA is that contributions are tax deductible and you can make them at any time until your taxes are due in mid-April of the following year.

The plan is also easy to set up and maintain.

If you have employees, you can establish a SEP IRA for yourself as well as your eligible employees. You can then make retirement plan contributions to a SEP IRA on your employees’ behalf. (All contributions to a SEP are made by the employer only, though employees own their accounts.)

SEP IRA contribution limits are, for the most part, the same for both employers and employees. This means that you need to make the same percentage of contribution for each employee that you make for yourself. That means if you contribute 15% of your compensation for yourself, you must contribute 15% of each employee’s compensation (subject to contribution limits).

A SEP IRA also offers flexibility. You don’t have to contribute to it every year.

However, under SEP IRA rules, no catch-up contributions are allowed. There’s no Roth option with a SEP IRA either.

Eligibility and Contribution Limits

Here’s what you need to know about who is eligible for a SEP IRA vs. a Solo 401(k), along with the contribution limits for both plans for 2024 and 2025.

Who Qualifies for a Solo 401(k) or SEP IRA?

Self-employed individuals and business owners with no employees (aside from their spouse) can open and contribute to a solo 401(k). There are no income restrictions on these plans.

SEP IRAs are available to self-employed individuals or business owners with employees. A SEP IRA might be best for those with just a few employees because IRS rules dictate that if you have one of these plans, you must contribute to a SEP IRA on behalf of your eligible employees (to be eligible, the employees must be 21 or older, they must have worked for you for three of the past five years, and they must have earned at least $750 in the tax year).

Plus, the amount you contribute to your employees’ plan must be the same percentage that you contribute to your own plan.

Contribution Comparison

With a solo 401(k), there are rules regarding contributions, including contribution limits. For 2025, you can contribute up to $70,000, plus an additional catch-up contribution of $7,500 for those age 50 and older. In 2026, you can contribute up to $72,000, plus an extra catch-up contribution of $8,000 for those age 50 and older. Also, in 2025 and 2026, those aged 60 to 63 may contribute an additional catch-up of $11,250 instead of $7,500 and $8,000 respectively, thanks to SECURE 2.0.

For the purposes of a solo 401(k) you play two roles — employer and employee. As an employee, you can contribute the lesser of 100% of your compensation or up to $23,500 in 2025 and up to $24,500 in 2026. If you’re 50 or older, you can contribute the $7,500 catch-up contribution in 2025, and $8,000 in 2026. And if you’re aged 60 to 63, in 2025 and 2026, you may contribute an additional $11,250 instead of $7,500 (in 2025) or $8,000 (in 2026). As an employer, you can make an additional contribution of 25% of your compensation (up to $350,000 in 2025, and up to $360,000 in 2026) or net self-employment income.

The contribution limits for a SEP IRA are the lesser of 25% of your compensation or $70,000 in 2025 and $72,000 in 2026. As mentioned earlier, there are no catch-up contributions with this plan.

And remember, per the IRS, if you have a SEP IRA, you must contribute to the plan on behalf of your eligible employees. The amount you contribute to your employees’ plan must be the same percentage that you contribute to your own plan.

💡 Quick Tip: Look for an online brokerage with low trading commissions as well as no account minimum. Higher fees can cut into investment returns over time.

Key Differences That Could Influence Your Decision

When you’re deciding between a solo 401(k) vs. a SEP IRA, consider the differences between the two plans carefully. These differences include:

Roth Options and Tax Benefits

With a solo 401(k), you can choose between a traditional and Roth solo 401(k), depending on which option’s tax benefits make the most sense for you. If you expect to be in a higher tax bracket when you retire, a Roth may be more advantageous since you can pay taxes on your contributions upfront and get distributions tax-free in retirement.

On the other hand, if you anticipate being in a lower tax bracket at retirement, a traditional solo 401(k) that lets you take deductions on your contributions now and pay tax on distributions in retirement could be your best option.

Loan Options and Investment Flexibility

You may also be able to take a loan from a solo 401(k) if your plan permits it. Solo 401(k) loans follow the same rules as traditional 401(k) loans.

If you need to take money from a SEP IRA before age 59 ½, however, you may pay an early withdrawal penalty and owe income tax on the withdrawal.

Both solo 401(k)s and SEP IRA offer more investment options than workplace 401(k)s. So you can choose the investment options that best suit your needs.

The Impact of Having Employees

Whether you have employees or not will help determine which type of plan is best for you.

A solo 401(k) is designed for business owners with no employees except for a spouse.

A SEP IRA is for those who are self-employed or small business owners. A SEP IRA may be best for those who have just a few employees since, as discussed above, you must contribute to a SEP IRA on behalf of all eligible employees and you must contribute the same percentage of compensation as you contribute for yourself.

The Financial Implications for Your Business

The plan you choose, solo 401(k) vs. SEP IRA, does have financial and tax implications that you’ll want to consider carefully. Here’s a quick comparison of the two plans.

Solo 401(k) vs SEP IRA at a Glance

Both solo 401(k) plans and SEP IRAs make it possible to save for retirement as a self-employed person or business owner when you don’t have access to an employer’s 401(k). And both can potentially offer a tax break if you’re able to deduct contributions each year.

Here’s a rundown of the main differences between a 401(k) vs. SEP IRA.

Solo 401(k)

 SEP IRA
Tax-Deductible Contributions Yes, for traditional solo 401(k) plans Yes
Employer Contributions Allowed Yes Yes
Employee Contributions Allowed Yes No
Withdrawals Taxed in Retirement Yes, for traditional solo 401(k) plans Yes
Roth Contributions Allowed Yes No
Catch-Up Contributions Allowed Yes No
Loans Allowed Yes No

How These Plans Affect Your Bottom Line

Both solo 401(k)s and SEP IRAs are tax-advantaged accounts that can help you save for retirement. With a SEP IRA, contributions are tax deductible, including contributions made on employees’ behalf, which offers a tax advantage. Solo 401(k)s give you the option of choosing a traditional or Roth option so that you can pay tax on your contributions upfront and not in retirement (traditional), or defer them until you retire (Roth).

Making the Choice Between SEP IRA and Solo 401(k): Which Is Right for You?

An important part of planning for your retirement is understanding your long-term goals. Whether you choose to open a solo 401(k) or make SEP IRA contributions can depend on how your business is structured, how much you want to save for retirement, and what kind of tax advantages you hope to enjoy along the way.

When to Choose a Solo 401(k)

If you’re self-employed and have no employees (or if your only employee is your spouse), you may want to consider a solo 401(k). A solo 401(k) could allow you to save more for retirement on a tax-advantaged basis compared to a SEP IRA. A solo 401(k) allows catch-up contributions if you are 50 or older, and you can also take loans from a solo 401(k).

Just be aware that a solo 401(k) can be more work to set up and maintain than a SEP IRA.

When to Choose a SEP IRA

If you’re looking for a plan that’s easy to set up and maintain, a SEP IRA may be right for you. And if you have a few employees, a SEP IRA can be used to cover them as well as your spouse. However, you will need to cover the same percentage of contribution for your employees as you do for yourself.

Remember that a SEP IRA does not allow catch-up contributions, nor can you take loans from it.

Step-by-Step Guide to Opening Your Account

You can typically set up a SEP IRA with any financial institution that offers other retirement plans, including an online bank or brokerage. The institution you choose will guide you through the set-up process and it’s generally quick and easy.

Once you establish and fund your account, you can choose the investment options that best suit your needs and those of any eligible employees you may have. You will need to set up an account for each of these employees.

To open a Solo 401(k), you’ll need an Employee Identification Number (EIN). You can get an EIN through the IRS website. Once you have an EIN, you can choose the financial institution you want to work with, typically a brokerage or online brokerage. Next, you’ll fill out the necessary paperwork, and once the account is open you’ll fund it. You can do this through direct deposit or a check. Then you can set up your contributions.

Additional Considerations for Retirement Planning

Besides choosing a SEP IRA or a solo 401(k), there are a few other factors to consider when planning for retirement. They include:

Rollover Process

At some point, you may want to roll over whichever retirement plan you choose — or roll assets from another retirement plan into your current plan. A SEP IRA allows for either option. You can generally roll a SEP IRA into another IRA or other qualified plan, although there may be some restrictions depending on the type of plan it is. You can also roll assets from another retirement plan you have into your SEP.

A solo 401(k) can also be set up to allow rollovers. You can roll other retirement accounts, including a traditional 401(k) or a SEP IRA, into your solo 401(k). You can also roll a solo 401(k) into a traditional 401(k), as long as that plan allows rollovers.

Can You have Both a SEP IRA and a Solo 401(k)?

It is possible to have both a SEP IRA and a solo 401(k). However, how much you can contribute to them depends on certain factors, including how your SEP was set up. In general, when you contribute to both plans at the same time, there is a limit to how much you can contribute. Generally, your total contributions to both are aggregated and cannot exceed more than $70,000 in 2025 and $72,000 in 2026.

Preparing for Retirement Beyond Plans

Choosing retirement plans is just one important step in laying the groundwork for your future. You should also figure out at what age you can retire, how much money you’ll need for retirement, and the typical retirement expenses you should be ready for.

Working on building your retirement savings is an important goal. In addition to opening and contributing to retirement plans, other smart strategies include creating a budget and sticking to it, paying down any debt you have, and simplifying your lifestyle and cutting unnecessary spending. You may even want to consider getting a side hustle to bring in extra income.

The Takeaway

Saving for retirement is something that you can’t afford to put off. And the sooner you start, the better so that your money has time to grow. Whether you choose a solo 401(k), SEP IRA, or another savings plan, it’s important to take the first step toward building retirement wealth.

Ready to invest for your retirement? It’s easy to get started when you open a traditional or Roth IRA with SoFi. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).

Help grow your nest egg with a SoFi IRA.

About the author

Rebecca Lake

Rebecca Lake

Rebecca Lake has been a finance writer for nearly a decade, specializing in personal finance, investing, and small business. She is a contributor at Forbes Advisor, SmartAsset, Investopedia, The Balance, MyBankTracker, MoneyRates and CreditCards.com. Read full bio.


Photo credit: iStock/1001Love

INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE

SoFi Invest is a trade name used by SoFi Wealth LLC and SoFi Securities LLC offering investment products and services. Robo investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser. Brokerage and self-directed investing products offered through SoFi Securities LLC, Member FINRA/SIPC.

For disclosures on SoFi Invest platforms visit SoFi.com/legal. For a full listing of the fees associated with Sofi Invest please view our fee schedule.

Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

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Can a Roth IRA Lose Money?

By | Growing Wealth, Investing, Preparing for Retirement | Comments Off on Can a Roth IRA Lose Money?

It is possible to lose money when you invest in a traditional or Roth IRA (Individual Retirement Account), depending on what investments you choose for your Roth. All investments can lose money — including those within any type of retirement account.

That’s why it’s important to invest your Roth in assets that reflect your risk tolerance. If you invest mostly in stocks, you are at a higher risk for losses in your account. If you invest in less volatile assets (e.g. bond funds), you may be at a lower risk for losses.

Are Roth IRAs safe? No investment account is ever 100% safe, but because retirement accounts are generally long-term investments, they offer the possibility of growth over time. Also, the more years you invest in a traditional or Roth IRA, the more time that retirement account may have to recover from any losses.

Key Points

•   It is possible to lose money in a Roth IRA depending on the investments chosen.

•   Roth IRAs are not 100% safe, but they offer the potential for growth over time.

•   Market fluctuations and early withdrawal penalties can cause a Roth IRA to lose money.

•   Investing late or contributing too much can also result in potential losses.

•   Diversification and considering time horizon can help mitigate risks in a Roth IRA.

Understanding IRAs

An IRA is a type of tax-advantaged account that may help individuals plan and save for retirement. IRAs can offer investors specific tax advantages that could be beneficial when compared with traditional brokerage accounts (which can be taxed as income).

There are also a few types of IRAs, with the most popular or well-known being the traditional IRA and Roth IRA account.

With a traditional IRA your contributions are pre-tax, meaning the amount you deposit in an IRA is deducted from your taxable income and is therefore not taxed until you withdraw the funds.

The key distinction is that contributions to Roth IRAs involve money that’s already been taxed, so it grows tax free, and withdrawals are also tax free. More on the differences between them below.

Get a 1% IRA match on rollovers and contributions.

Double down on your retirement goals with a 1% match on every dollar you roll over and contribute to a SoFi IRA.1

1Terms and conditions apply. Roll over a minimum of $20K to receive the 1% match offer. Matches on contributions are made up to the annual limits.

Can You Lose Money in a Roth IRA?

Now, to the main question: Can a Roth IRA lose money? The answer is yes, it can. This is one of the main differences between a Roth IRA vs. savings: Investing involves risk, whereas parking your money in the bank usually does not (with the exception of inflation risk).

There are several reasons that your Roth IRA may lose money.

Market Fluctuations

Given that the money in retirement accounts, including IRAs, is typically invested, the overall value of the account is subject to the whims of the market. That means that if the market experiences a downturn or correction, your Roth IRA balance is likely to decline as well.

That’s not a certainty, however, as IRAs are generally invested in a range of assets, not all of which may be affected by larger market conditions.

Early Withdrawal Penalties

Your Roth IRA can also lose money if you withdraw funds from it prematurely, and thus, are forced to pay early withdrawal penalties. Roth IRAs are complicated, however, in that your contributions can be withdrawn at any time. But you have to be careful with earnings.

If you withdraw earnings from your Roth IRA before age 59 ½ , you’ll likely be assessed a 10% penalty by the IRS.

Depending on the type of IRA you have, you may also need to pay ordinary income taxes, too.

You may want to consult a tax professional to make sure you understand Roth IRA rules that can trigger penalties.

Investing Late

It’s also possible to “lose money” in the sense that you miss out on market gains over time by investing in your Roth IRA too late. Time is an important factor in investing and saving for retirement, and if you start relatively young, time will work for you as the markets tend to rise over the years.

But if you’re about to hit retirement age and have only been investing in your Roth IRA for, say, a few years, you likely missed out on many years’ of appreciation by investing too late. This is why it’s generally a good idea to start funding an IRA as soon as possible.

Contributing Too Much

It’s possible to contribute too much to your Roth IRA, which may end up costing you. There are limits to how much you can contribute each year. For tax year 2025, the annual contribution limit for Roth IRAs is $7,000. These IRAs allow for a catch-up contribution of up to $1,000 per year in 2025 if you’re 50 or older.

For tax year 2026, the annual contribution limit is $7,500, with an additional catch-up contribution of up to $1,100 for those 50 and older. If you blow past those maximums, you must withdraw the excess amount or it can trigger a 6% tax penalty from the IRS.

Note that if your modified adjusted gross income (MAGI) reaches a certain amount, you cannot contribute the maximum amount to a Roth IRA. In 2025, those amounts are $150,000 for single filers and $236,000 for those married and filing jointly. In 2026, those amounts are $153,000 for single filers and $242,000 for those married and filing jointly.

Allowable contributions are gradually reduced up until certain MAGI caps, at which point you cannot contribute to a Roth IRA at all. In 2025, those caps are $165,000 for single filers and $246,000 for married couples filing jointly, and in 2026, the caps are $168,000 for single filers and $252,000 for married couples filing jointly.

Custodial Fees

There are also fees to consider. Someone manages your Roth IRA, and they don’t do it for free. As such, you may incur managerial or custodial fees that can affect your account’s overall balance, in addition to the cost of the investments themselves.

Can You Lose Your Entire Roth IRA?

It’s unlikely that you’d lose your entire Roth IRA’s value. Most fees, penalties, and taxes are levied as a percentage of that value, so they would not be able to fully drain the account. Perhaps the closest you could get to losing all of the money in your Roth IRA is if the market sees an all-out collapse, and most assets see their values reduced to zero.

Again — that’s very unlikely, but not impossible. If it were to happen, too, you’d probably have bigger problems to worry about other than the value of your investments!

With all of this in mind, it’s fair to ask, Are Roth IRAs safe to invest your money in?

The answer is that IRAs in general can provide less risk exposure than, say, day trading, although there are still risks to take into consideration. A Roth IRA that’s 100% invested in equities could be quite risky compared with a Roth invested in other assets (e.g. bonds or bond funds, mutual funds, and so on).

Also, the assets in a Roth IRA are usually long-term investments, which tend to help mitigate the risk of losses over time, as your money may have a chance to recover from any market downturns.

Limiting Risk in IRAs

One thing all of the IRAs above have in common is they offer the individuals who hold them a lot of flexibility in investment choices — including mutual funds, property, stocks, bonds, ETFs, annuities, and more. As a result, IRA investors can have a big say in what their retirement portfolio will look like.

And while it is possible that their portfolio may lose money, there are ways to manage that risk. By contrast, 401(k) retirement plans often offer limited investment options, such as a handful of mutual funds or target date funds.

Diversification

Diversification is chief among an investor’s risk management tools. A diversification strategy means spreading money across multiple asset classes, such as stocks and bonds. A portfolio can be further diversified within each asset class. For example, diverse stock holdings might include stocks from companies of different sizes, sectors, and geographical locations.

Diversification helps minimize the effects market risk can have on an investor’s portfolio. There are two main types: market risk, also called systematic risk, and specific or unsystematic risk.

Systematic risk is caused by factors that have a broad impact on the market as a whole, such as inflation or a global pandemic. Unfortunately, there’s not much an investor can do about this sort of risk, unless you’re an active investor familiar with hedging strategies.

The second type of market risk, unsystematic risk, is limited to individual companies, industries, or geographies. For instance, a workers’ strike at a factory could halt production and drag down an automaker’s stock price.

Diversification helps mitigate unsystematic risk. So, if an individual holds stocks in hundreds of different companies, one poorly performing company may have minimal negative impact on their portfolio’s performance. While diversification cannot prevent the risk of loss entirely, it may help individuals’ portfolios less vulnerable to market volatility.

How Safe Are Roth IRAs Considered to Be?

It depends how you define “safe.” If you’re thinking 100% free from loss, there are no safe investments. That said, Roth IRAs, and many other retirement account types, are generally considered to provide investors with lower risk exposure. They’re generally safer than investing in, say, penny stocks or cryptocurrencies, which are usually referred to as “speculative” investments.

Roth IRAs are usually managed and diversified, and as such, have some degrees of safety built into them to keep investors’ money relatively safe. That said, they aren’t completely risk-free. As mentioned, there are things that can lower a Roth IRA’s overall value — some of which investors can attempt to mitigate.

Time Horizon for Investments

Some investors might want to consider their time horizon in an effort to minimize portfolio losses that can occur at inopportune times. A time horizon is the amount of time an investor anticipates holding an investment until they want the money back.

When an investor is young, they may choose to hold riskier investments, such as stocks in their portfolio. Stocks can offer more opportunity for growth, but — on the flip side — stocks can also suffer big drops in value.

Investors who are many years away from a financial goal, such as retirement, may opt to hold more stocks to take advantage of their growth potential. With many years to go before they need to tap their investments, these investors have time to ride out the market’s swings.

Test your understanding of what you just read.

The Takeaway

It’s possible to lose money in a Roth IRA, or any retirement or investment account — it really depends what types of investments are in the Roth.

The market may take a dip, for example, which can have an effect on your Roth IRA’s overall value. You can also see some of that value eaten up by custodial fees or penalties, if you decide to withdraw money. In a broader sense, if you start investing too late, you can miss out on market gains over many years — likewise costing you money.

It’s unlikely you would see your entire Roth IRA’s value fall to zero. But it’s also important to remember that retirement accounts are not risk-free investment vehicles. And depending on the type of IRA you have (traditional or Roth, SEP or SIMPLE), there will be different considerations you’ll need to make about how, when, and why you’re investing.

Ready to make an IRA part of your retirement plan? Learn more about opening an IRA with SoFi Invest®. SoFi doesn’t charge commissions (you can read the full fee schedule here), and members have access to a complimentary 30-min session with a SoFi Financial Planner.

Help grow your nest egg with a SoFi IRA.

FAQ

What happens to my Roth IRA if the stock market crashes?

It’s likely that you would see the overall value of your Roth IRA diminish in the event of a stock market crash. That doesn’t mean that it would have no value or you’d lose all of your money, but fluctuations in the market do affect the values of the investments in IRAs.

What are the risks of investing in a Roth IRA?

Risks of investing in a Roth IRA involve potentially incurring penalties for early withdrawals, seeing values decline due to market fluctuations, and even the potential of being assessed tax penalties for contributing too much money during a given year, among other things.

INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE

SoFi Invest is a trade name used by SoFi Wealth LLC and SoFi Securities LLC offering investment products and services. Robo investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser. Brokerage and self-directed investing products offered through SoFi Securities LLC, Member FINRA/SIPC.

For disclosures on SoFi Invest platforms visit SoFi.com/legal. For a full listing of the fees associated with Sofi Invest please view our fee schedule.

Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.

Investment Risk: Diversification can help reduce some investment risk. It cannot guarantee profit, or fully protect in a down market.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Third Party Trademarks: Certified Financial Planner Board of Standards Center for Financial Planning, Inc. owns and licenses the certification marks CFP®, CERTIFIED FINANCIAL PLANNER®

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Custodial Roth IRA: How to Open a Roth IRA For Kids

By | Growing Wealth, invest, Investing, Preparing for Retirement | Comments Off on Custodial Roth IRA: How to Open a Roth IRA For Kids

A Roth IRA can be a retirement savings tool for children as well as adults. Funded with after-tax dollars, a Roth IRA grows tax-free, so account holders won’t need to pay taxes when they withdraw money in retirement as long as the account has been open for at least five years. Plus, the money in a Roth IRA will have many decades to grow if you open it when your child is young.

And while a Roth IRA has an early distribution penalty, that penalty is generally waived for certain expenses, such as paying for qualified college expenses, if your child needs to access those funds. That flexibility can make a Roth IRA appealing.

Can you open a Roth IRA for a child? Yes! A Roth IRA for kids, called a Custodial Roth IRA, can be opened by a parent, grandparent, or other adult for a child of any age, as long as the child earns income (more on that later).

Here’s everything you need to know about a Roth IRA for kids.

🛈 Currently, SoFi does not offer custodial banking or investment products.

What Is a Roth IRA for Kids?

A Roth IRA for kids, also known as a custodial Roth IRA, is an IRA opened by an adult (usually a parent), who manages the account until the child gets full control of it, which is at age 18 or 21 in most states.

A custodial Roth IRA for kids generally operates in the same way a Roth IRA for adults does. The account holder contributes after-tax dollars toward their retirement savings and the money grows tax-free in the account.

In order to open and contribute to a Roth IRA, your child must have earned income.

Who’s Eligible for a Roth IRA for Kids?

A child of any age can have a Roth IRA for kids. However, to be eligible, a child must have an earned income. Earned income can include the compensation earned from jobs like babysitting, dog walking, or working for an employer.

Custodial Roth IRA Rules

In addition to the standard rules for a Roth IRA, there are specific rules for custodial Roth IRAs. These rules include:

No Minimum Age Limit

A child of any age can have a custodial Roth IRA as long as he or she has earned income.

A Child Must Have Earned Income

In order to open a custodial Roth IRA, a child must have earned income. The IRS generally defines earned income as taxable income, wages, and tips. This can also include self-employment, such as yard work or babysitting. Cash gifts given to a child do not count as earned income.

There Are Contribution Limits

The 2025 contribution limit for a Roth IRA is $7,000 ($8,000 for those 50 and older). For 2026, the contribution limit is $7,500 ($8,600 for those 50-plus). You may also be limited by your Modified Adjusted Gross Income (MAGI) depending on your filing status.

In addition, a child (or an adult on behalf of a child) cannot contribute an amount greater than the child’s earned income. So if a child earned $2,000 as a lifeguard at the local swimming pool, for example, the most that can be contributed to the child’s custodial IRA that year, including contributions from parents, is $2,000.

Certain Early Withdrawals Are Allowed

In general, you can withdraw contributions from a Roth IRA at any time without penalty. Earnings typically can’t be withdrawn before age 59 ½ without penalty except in certain circumstances. Allowable exceptions include withdrawals up to certain limits to pay for qualified college expenses, cover certain medical bills, and to buy a first home.

Eventual Conversion to a Regular Roth IRA

When the child reaches the legal age in their state (typically 18 or 21, depending on the state), the custodial Roth IRA will need to be converted to a regular Roth IRA in the child’s name.

How to Open a Custodial Roth IRA for a Kid

A Roth IRA for kids can be opened by any adult, such as a parent or grandparent, for instance. While the child is a minor, the adult will have sole access to the account; once the child comes of age (the timing of which varies by state), the account will transfer over to the child.

As with any Roth IRA, investment options within the account can include stocks, bonds, and mutual funds.

A Roth IRA can be opened through a financial institution or brokerage firm. You can typically open the account online by providing some basic information about yourself and your child. Choosing the right institution and Roth IRA offering depends on the investor and their preferences, so be sure to do some research.

Benefits of Starting a Roth IRA for a Child

Flexibility in how to use the funds can be one benefit of opening a custodial Roth IRA as part of an investment plan for your child. A Roth IRA can provide flexibility not only for potential expenses in early adulthood — such as college expenses or buying a home — but can be an investment vehicle throughout your child’s lifetime.

Another benefit is that a Roth IRA typically gives you more control over investments than an education-focused 529 college savings plan, and it may allow you to create a diversified portfolio of different asset classes.

A Roth IRA is a gift that can keep growing, since investors can potentially maximize compounding returns to get the most out of their investment. Here’s how a Roth IRA may unlock the power of compounding: As an example, let’s say you open a custodial Roth IRA when the child is 10 years old, and contribute $2,000 annually. At a certain point, your child might take over contributing $2,000 annually.

Assuming a 7% rate of return, the account will be worth $928,000 by the time your child is 60 years old — even though the amount you and your child contributed would be $100,000 in total. In comparison, if that same money was put in a taxable savings account over the same time period, the total of the account would be approximately $515,764.

And unlike a traditional IRA, there is no required minimum distribution (RMD) on a Roth IRA once the account owner reaches retirement age. A Roth IRA also allows people to continue contributing throughout their lifetime, as long as they’re earning income.

Alternatives to a Roth IRA for a Kid

If you’re looking for other possible investments for your child, some options to consider include the following.

•   Savings account: A parent can open a savings account for a child, as long as the parent is a joint account holder. Savings accounts typically have low interest rates (the average rate for a savings account is 0.42% APY as of December 16, 2024), so you might want to look for a high-yield savings account instead. These accounts may have average rates of more than 3.00% APY.

•   Savings bonds: If your child doesn’t have earned income, you may want to consider savings bonds. However, savings bonds don’t offer the same potential tax advantages a Roth IRA does since you have to pay federal income tax on the bonds when they mature or you cash them. You won’t pay income taxes on Roth IRA earnings unless you take a non-qualified distribution.

•   529 plans: These plans can help you save for your child’s education. You can typically invest the money you contribute to a 529 plan and choose from a wide range of investment options. While these plans aren’t tax deductible at the federal level, your state may offer tax breaks for contributions made to them. And funds can be withdrawn tax-free for qualified education expenses. Also, money left in a 529 may be rolled over to a Roth IRA for your child, although certain conditions and limits may apply.

•   UGMA/UTMA accounts: A Uniform Gifts to Minors Act (UGMA) account and a Uniform Transfers to Minors Act (UTMA) account are custodial accounts in which an adult can invest on behalf of a child. These accounts are typically used to invest in stocks, bonds, mutual funds, and so on. There are no contribution or income limits, and gifts below the annual gift threshold do not need to be reported. However, there are no tax benefits when contributions are made, and earnings are made to these accounts, and earnings are subject to taxes. When the child reaches legal age, they take over control of the account.

The Takeaway

For a child with earned income, a custodial Roth IRA may be a good way to help them prepare for their future and get started on the path to investing. A child does need to have an earned income to open a custodial Roth IRA, and contributions cannot exceed their income. If your child qualifies, a Roth IRA for kids could potentially give them years of tax-free growth on their money.

FAQ

Can you open a Roth IRA for a child if they don’t earn income?

No. A child must have earned income — which the IRS defines as wages, salaries, tips and other taxable employee compensation, as well as net earnings from self-employment — in order to open a custodial Roth IRA.

Can you open a Roth IRA for a baby?

It’s possible to open an IRA for a baby. As long as a baby earns an income — modeling baby clothes, for instance — you can open a custodial Roth IRA for them. There is no minimum age to open a custodial Roth IRA, but the child must have earned income.

Is it a good idea to open a Roth IRA for a child?

It may be a good idea to open a Roth IRA for a child for several reasons. A Roth IRA can help a child save up for and cover certain expenses in early adulthood, such as qualified college expenses. Also, a Roth IRA typically has higher returns than a savings account. And because kids have a low tax rate now, when contributions are made, it makes sense to open a Roth IRA, which is taxed upfront. At retirement, as long as they are at least age 59 ½, they can withdraw the money tax-free.

Can I give my child money for a Roth IRA?

Yes, you can contribute to your child’s IRA. However, annual contributions to the account cannot exceed the child’s annual earned income. Also, per IRS rules, the overall amount you can contribute to a Roth IRA is to $7,000 in 2025 ($7,500 in 2026) for individuals under age 50, or the total annual earned income, whichever is less.

What is the disadvantage of a Roth IRA for kids?

One potential disadvantage of an IRA for kids is that your child must earn an income in order to open and contribute to an account. In addition, you can only contribute the amount the child earns. So if the child makes $500 for the year babysitting, that is the most you can contribute to their custodial Roth IRA.

Can I open a Roth IRA for my 2 year old?

As long as your 2-year-old earns an income, you can open a custodial Roth IRA for them. There is no minimum age requirement for a Roth IRA for kids.

How do I prove my child’s income for a Roth IRA?

If your child receives a W-2 or 1099 form for work they did for an employer, you can use those documents to prove your child’s income. However, if they are self-employed and do work like babysitting, dog walking or yard work to earn money, you should keep receipts or records of the type of work they did, the amount they earned, when the work was done, and who it was for, as proof of their income.

What happens to a custodial Roth IRA when the child turns 18?

Once a child is of legal age, which is typically 18 or 21, depending on your state, the IRA must be converted to a regular Roth IRA in the child’s name that they then own and manage.

Do children need to file a tax return to fund their Roth IRA?

As long as their income is below the threshold that requires them to file a tax return, children are typically not required to file a tax return just because they have a custodial IRA. However, you may want to consult with a tax professional about your specific situation.

Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE

SoFi Invest is a trade name used by SoFi Wealth LLC and SoFi Securities LLC offering investment products and services. Robo investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser. Brokerage and self-directed investing products offered through SoFi Securities LLC, Member FINRA/SIPC.

For disclosures on SoFi Invest platforms visit SoFi.com/legal. For a full listing of the fees associated with Sofi Invest please view our fee schedule.

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Individual Retirement Account (IRA) vs Thrift Savings Plan (TSP)

By | invest, Investing, Preparing for Retirement | Comments Off on Individual Retirement Account (IRA) vs Thrift Savings Plan (TSP)

Although an IRA and a TSP are both types of retirement accounts, they are governed by different sets of rules, starting with the fact that anyone with earned income can open an IRA, but only employees of the U.S. government or the armed forces can fund a thrift savings plan.

A TSP effectively functions more like the government version of a 401(k) plan, with similar rules and contribution limits to these private company-sponsored plans.

When considering the advantages of an IRA vs. a TSP, remember that in many cases it’s possible to fund both types of accounts, as long as you understand the rules and restrictions that apply to each.

What Is an IRA?

You may already be familiar with what IRAs are: These are individual retirement accounts that are tax advantaged in different ways. Anyone with earned income can open an IRA, as long as they meet certain criteria.

Retirement savers can generally choose between traditional and Roth IRAs, with some exceptions owing to Roth eligibility rules (more on that below).

Traditional IRAs allow for pre-tax contributions, while Roth IRAs involve after-tax contributions and permit qualified tax-free withdrawals in retirement.

For tax year 2025, the maximum annual amount you can contribute to either type of IRA is $7,000; $8,000 if you’re 50 or older. For tax year 2026, the maximum amount you can contribute to either type of IRA for the year is $7,500; $8,600 if you’re 50 or older. These amounts are the total annual contribution amounts allowed across all ordinary IRA accounts.

So, if you contribute $3,000 to a Roth IRA in 2025 and you’re under age 50, then you can only contribute up to $4,000 in another IRA for that year. And if you contribute $3,000 to a Roth IRA in 2026 and you’re under age 50, you can only contribute up to $4,500 in another IRA for the year.

Calculate your IRA contributions.

Use SoFi’s IRA contribution calculator to determine how much you can contribute to an IRA in 2024.

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What Is a TSP?

The Thrift Savings Plan (TSP) is an employer-sponsored plan that is open to members of the military and civilian employees of the federal government. TSPs are tax-advantaged plans that share many similarities to 401(k) plans offered by private employers.

Like 401(k) plans, you can contribute to a traditional TSP or a designated Roth TSP, both of which come with the types of tax advantages that are similar to traditional and Roth IRAs, as described above. In other words, many different types of retirement accounts may also offer a Roth-style option, for after-tax contributions. Be sure to check the rules and restrictions on contributing to both sides of a plan.

Perhaps the biggest difference with a TSP vs. an IRA is the annual contribution limit. You can contribute up to $23,500 for tax year 2025; for those 50 and older there is also an annual catch-up contribution of up to $7,500 per year, for a total of $30,500. Also, in 2025, those aged 60 to 63 may contribute a catch-up of up to $11,250 (instead of $7,500) for a total of $34,750, thanks to SECURE 2.0.

For 2026, you can contribute up to $24,500, and there is a catch-up contribution of up to $8,000 for those age 50 and up for a total of $32,500. Also, in 2025, those aged 60 to 63 may again contribute a catch-up of up to $11,250 (instead of $8,000) for a total of $35,750.

But contribution limits for IRAs are $7,000 for tax year 2025 ($8,000 for those 50 and up), and $7,500 for tax year 2026 ($8,600 for those 50 and older).

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1Terms and conditions apply. Roll over a minimum of $20K to receive the 1% match offer. Matches on contributions are made up to the annual limits.

TSP vs. IRA

In addition, there are other similarities and differences between a TSP and an IRA.

Similarities

Both the TSP and IRAs provide tax-advantaged ways to save for retirement. With both TSPs and IRAs you can choose between a traditional (tax-deferred) account or a Roth (tax-free) account.

•   With a traditional-style TSP or IRA, funds are deposited pre-tax, and you owe ordinary income tax on the withdrawals.

•   With a Roth-style TSP or IRA, you deposit after-tax money, and qualified withdrawals are tax-free starting at age 59 ½, as long as you’ve held the account for at least five years.

•   With both types of accounts, you may face tax consequences and/or a penalty if you withdraw your funds before age 59 ½.

Differences

There are far more differences between TSPs and IRAs, as you’ll see in the table below.

IRAs

 TSP
Anyone with earned income can open an IRA Only members of the military and government employees are eligible
Annual contribution limits for 2025 are $7,000 and $8,000 with the catch-up provision; annual contribution limits for 2026 are $7,500 and $8,600 with the catch-up. Annual contribution limits for 2025 are $23,500; $31,000 with the catch-up provision and $34,750 for those aged 60 to 63; annual contribution limits for 2026 are $24,500; $32,500 with the catch-up provision and $35,750 for those aged 60 to 63.
A wide range of investment choices Investment choices are limited to the funds the TSP provides
You have some control over the investment fees you pay, so be sure to check your all-in costs. You have little control over the investment fees you pay, though TSP account and investment fees tend to be low.
You cannot take a loan from your IRA TSP loans may be available
You are solely responsible for contributions The government typically provides matching contributions of up to 5%
Traditional IRAs are subject to RMD rules; Roth IRAs are not RMD rules apply to TSPs, but there are different distribution options: e.g. an installment plan or a lifetime annuity, among other choices

Pros and Cons of IRAs

As the name suggests, an IRA is an account that you manage individually. As such, it comes with its own set of advantages and disadvantages.

Pros

•   You can open an IRA at most brokerage firms, and manage it yourself, as long as you have earned income.

•   An IRA account typically offers access to a wide range of investment options.

•   Traditional and Roth IRAs offer different tax treatments; you can choose whatever works best for your financial plan.

Cons

•   Annual contribution limits are lower than many other types of retirement plans.

•   Eligibility rules for Roth IRAs are complicated and can be limiting.

•   Only you can fund an IRA; there is no employer match for a traditional IRA or Roth.

•   You cannot take a loan from any type of IRA (but you may be able to take early withdrawals under some circumstances without owing a penalty; see IRS.gov).

Pros and Cons of TSPs

Remember that you can only participate in a TSP if you are an employee of the federal government or a member of the armed forces. Here are some other considerations.

Pros

•   The annual contribution limits are higher than IRAs, and the same as 401(k) plans.

•   TSPs include an employer match up to 5%.

•   When setting up your income plan in retirement, TSPs offer a range of options for taking withdrawals, including fixed installments and a lifetime annuity option.

•   You can take a loan from a TSP.

•   TSP accounts have lower fees, generally, than IRA accounts

Cons

•   Investment options within a TSP can be limited.

•   If you leave your government job, you can no longer contribute to your TSP.

•   TSP plan participants have less control, and cannot opt for lower-fee or investment options.

Can You Roll a TSP Into an IRA?

Yes, you can rollover your TSP funds into a qualified trust or eligible retirement plan. Eligible retirement plans include IRAs as well as qualified employer-sponsored plans.

Keep in mind that generally you generally need to rollover funds from a traditional TSP account into a traditional IRA and funds from a Roth TSP account into a Roth IRA in order to avoid taxes on the amount you rollover.

You may want to consult with a professional.

The Takeaway

The Thrift Savings Plan (TSP) is a government program intended to help government employees and members of the military save for retirement. It is an employer-sponsored plan similar to a 401(k). An individual retirement account (IRA) is also a way to save for retirement, but is an account you open and manage yourself.

While there are advantages and disadvantages to each, a TSP allows you to invest more of your savings over time; contribution limits are lower for traditional and Roth IRAs.

Ready to invest for your retirement? It’s easy to get started when you open a traditional or Roth IRA with SoFi. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).

Help grow your nest egg with a SoFi IRA.

FAQ

Is a TSP or IRA better?

A TSP and an IRA are two different ways to save for retirement, and may suit different people for different reasons. Contributing to an IRA may provide you with more investment options, while you can save more in a TSP and the government may match some of your contributions — but not everyone has access to a TSP.

Should you move your TSP to an IRA?

If you leave government service, you can’t contribute to your TSP anymore — but you may be able to open an IRA and rollover the TSP funds. Doing a TSP-to-IRA rollover within the standard 60-day window can help ensure that you don’t have to pay any taxes or penalties, and this may help your retirement plan.

Is a TSP the same as an IRA?

No, a TSP is not the same as an IRA. A TSP is for employees of the government or the armed forces, and it’s comparable to an employer-sponsored plan like a 401(k) or 403(b). By contrast, anyone can open an IRA, as long as they have earned income and qualify.

Photo credit: iStock/Dilok Klaisataporn

INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE

SoFi Invest is a trade name used by SoFi Wealth LLC and SoFi Securities LLC offering investment products and services. Robo investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser. Brokerage and self-directed investing products offered through SoFi Securities LLC, Member FINRA/SIPC.

For disclosures on SoFi Invest platforms visit SoFi.com/legal. For a full listing of the fees associated with Sofi Invest please view our fee schedule.

Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Disclaimer: The projections or other information regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results.

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The Pros and Cons of a Roth IRA

By | invest, Investing, Preparing for Retirement | Comments Off on The Pros and Cons of a Roth IRA

A Roth IRA offers a tax-advantaged way to save for retirement. Contributions to a Roth IRA are made with after-tax dollars, and qualified withdrawals in retirement are tax-free. Individuals with earned income up to certain limits may be eligible to contribute to a Roth IRA.

A Roth IRA also has some potential drawbacks, however. Weighing the pros and cons of a Roth IRA can help you decide whether it’s a good fit in your retirement portfolio.

What Is a Roth IRA?


A Roth IRA is an individual retirement account that’s funded with after-tax dollars. That means you can’t deduct Roth contributions from your taxes at the time you make them. But in retirement, at age 59 ½ and older, qualified withdrawals are tax-free. That’s the most straightforward way of defining a Roth IRA, and it’s also one of the reasons some investors are drawn to it.

You can have a Roth IRA in addition to a 401(k) or other workplace retirement savings plan. You could also open a Roth IRA to help save for retirement if you don’t have access to an employer-sponsored retirement plan.

The IRS sets annual contribution limits for Roth IRAs, and these limits are adjusted periodically for inflation. The contribution limit for a Roth IRA in both 2024 and 2025 is $7,000 per year, while those 50 and up can contribute up to $8,000 per year.

Roth IRA Eligibility


To open a Roth IRA, you must have earned income, but one of the cons of a Roth IRA is that there are limits on how much you can earn to be eligible.

The chart below illustrates what you can contribute to a Roth IRA based on your modified adjusted gross income (MAGI) and tax filing status.

Filing status 2025 MAGI 2026 MAGI Roth IRA contribution allowed
Single Up to $150,000 Up to $153,000 $7,000 ($8,000 for those 50 and older)
From $150,000 to $165,000 From $153,000 to $168,000 Partial contribution
$165,000 or more $168,000 or more $0
Married, filing jointly Up to $236,000 Up to $242,000 $7,000 ($8,000 for those 50 and older)
From $236,000 to $246,000 From $242,000 to $252,000 Partial contribution
$246,000 or more $252,000 or more $0
Married, filing separately Less than $10,000 Less than $10,000 Partial contribution
$10,000 and more $10,000 and more $0

As you can see, high-income earners may be ineligible for a Roth. You could, however, make contributions to a traditional IRA instead.

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1Terms and conditions apply. Roll over a minimum of $20K to receive the 1% match offer. Matches on contributions are made up to the annual limits.

Roth IRA vs. Traditional IRA


A traditional IRA is also a tax-advantaged individual retirement account. Traditional IRAs have the same annual contribution limits as Roth IRAs. The main difference between a traditional vs. Roth IRA is their tax treatment.

Traditional IRAs are funded with pre-tax dollars. That means you may be eligible to deduct some or all of the contributions you make each year. In retirement, you’ll pay income tax on qualified withdrawals.

The amount you can deduct in traditional IRA contributions depends on your income, tax filing status, and whether you’re covered by a retirement plan at work.

What Are the Pros and Cons of a Roth IRA?


Saving for retirement in a Roth IRA has advantages, but it may not be the right option for everyone. Here are pros and cons of Roth IRAs.

Pros of a Roth IRA


There are several advantages of a Roth IRA, including:

Tax-Free Growth and Withdrawals


Because Roth IRAs are funded with after-tax dollars, you’ve already paid tax on the money you contribute. Your money grows tax-free while it’s invested, and when you withdraw it in retirement, you pay no taxes on it.

Tax-free withdrawals are beneficial if you expect your income to be higher in retirement than it is during your working years. Any money you take out of a Roth IRA at age 59 ½ or older wouldn’t increase your tax liability as long as it’s a qualified withdrawal.

No Required Minimum Distributions


With traditional IRAs, account holders must begin taking required minimum distributions (known as RMDs) from their account annually once they reach age 73 (assuming they reach age 72 in 2023 or later). If you don’t withdraw the required amount on time, you are subject to a tax penalty.

Roth IRAs do not have RMDs. You can leave the money in your account for as long as you like.

Contributions Can Be Withdrawn Penalty-Free


Ideally, the concept of a Roth IRA is to leave your money in the account until retirement. At age 59 ½ you can begin taking distributions without facing a 10% early withdrawal penalty. However, you can withdraw the contributions you make to a Roth IRA penalty-free at any time.

Your earnings are a different matter. You cannot withdraw your earnings before age 59 ½ without incurring taxes and penalties.

Cons of a Roth IRA


There are some drawbacks to an IRA, which mean these accounts may not be a good fit for everyone. These are the main cons of a Roth IRA to consider.

No Tax Deduction


Roth IRAs don’t offer a tax deduction for the contributions you make. Instead, you have to wait until retirement to reap the tax benefits. Tax-free withdrawals in your golden years could be an advantage, however, if you anticipate being in a higher tax bracket in retirement.

Income Limits Apply


Earning a higher income could put a Roth IRA out of reach for certain individuals, as our chart above indicates. If you’re not eligible for a Roth because of your earnings, you could consider a backdoor Roth IRA.

With a backdoor Roth, you make nondeductible contributions to a traditional IRA and then convert that IRA to a Roth IRA. However, since you’re moving pre-tax dollars into an after-tax account, you’ll owe income taxes on a Roth IRA conversion at the time you complete it, which could be costly.

The 5-Year Rule


Unlike traditional IRAs, Roth IRA accounts are subject to the 5-year rule. This rule says that, barring certain exceptions, your account must be open for at least five years before you can withdraw the earnings tax- and penalty-free at age 59 ½. The 5-year rule also applies to IRA conversions.

Setting Up a Roth IRA


Opening a Roth IRA is relatively easy. You choose where to open the account, fill out the required paperwork, designate a beneficiary, and fund your account.

Like many other investment accounts, you can open a Roth IRA through an online brokerage and link a bank account to it to make your first contribution.

Once you add funds to your IRA, you can decide how to invest them. Typically, brokerages offer options such as mutual funds and index funds. If you’re looking for alternative investments you may want to consider opening a self-directed IRA instead.

Roth IRA Withdrawal Rules


You can withdraw your Roth IRA contributions at any time without taxes or penalties. However, when it comes to earnings, Roth IRA withdrawal rules can be complicated since you have to factor in the five-year rule.

To help simplify things, this at-a-glance chart shows how withdrawals of earnings from a Roth IRA work and when taxes and penalties apply.

Your age The account has been open less than five years The account has been open for five years or more
Under 59 ½ Withdrawals of earnings are subject to taxes and penalties, unless an exception (like a disability) applies. Withdrawals of earnings are not subject to taxes if the money is used for a first-home purchase or the account holder becomes disabled or passes away.
59 ½ or older Withdrawals of earnings are subject to taxes, but not penalties. Withdrawals of earnings are tax- and penalty-free.

Naming a Trust as Your Roth IRA Beneficiary


When you set up a Roth IRA, you need to name a beneficiary. Your beneficiary inherits the money in your Roth IRA after your death.

You can name an individual such as your spouse or child as your IRA beneficiary. You can also designate a trust as your beneficiary. A trust is a legal entity that you transfer your assets to. It’s administered by a trustee who manages your assets for you, according to your wishes.

For example, you might name a trust as the beneficiary of your Roth IRA if you’d like a say in what happens to your assets once you pass away. If you leave your IRA to an individual, they can do what they like with it. A trust allows you to leave specific instructions about how the assets in the trust can be used.

The Takeaway


A Roth IRA offers some unique benefits when it comes to retirement savings. With a Roth IRA, your money grows tax-free, you can make tax-free qualified withdrawals in retirement, and there’s no need for RMDs.

But not everyone is eligible to open a Roth IRA. There are income limits on these accounts, plus you must have funded a Roth for at least five years in order to make qualified withdrawals of your earnings without facing taxes and a penalty.

For those who are eligible for a Roth IRA, the prospect of tax-free withdrawals in retirement may make the potential downsides worth it. Consider all the pros and cons of a Roth IRA to make an informed decision about whether this type of retirement account is right for you.

Ready to invest for your retirement? It’s easy to get started when you open a traditional or Roth IRA with SoFi. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).

FAQs

Are Roth IRAs considered a safe investment?


A Roth IRA is not an investment; it’s an individual retirement account into which you put money that you plan to invest. Your choice of investments, and your risk tolerance, can determine how “safe” your Roth IRA may be. When comparing different investments, consider the risk and possible reward of each one to determine if you’re comfortable with it.

Do Roth individual retirement accounts have income limits?


Roth IRAs do have income limits set by the IRS and updated annually that determine who can contribute. These limits are based on your modified adjusted gross income (MAGI). If your MAGI exceeds the limit allowed for your filing status, you won’t be able to make a Roth IRA contribution. For example, in 2024, a single person with a MAGI of $161,000 or more and a person married filing jointly with a MAGI of $240,000 or more are not eligible to contribute to a Roth IRA.

How much can you contribute to a Roth IRA?


The annual Roth IRA contribution limit is set by the IRS. For tax years 2024 and 2025, the annual contribution limit for Roth IRAs is $7,000. These IRAs allow for a catch-up contribution of up to $1,000 per year if you’re 50 or older, for a total of $8,000 each year.

About the author

Rebecca Lake

Rebecca Lake

Rebecca Lake has been a finance writer for nearly a decade, specializing in personal finance, investing, and small business. She is a contributor at Forbes Advisor, SmartAsset, Investopedia, The Balance, MyBankTracker, MoneyRates and CreditCards.com. Read full bio.


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Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

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INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE

SoFi Invest is a trade name used by SoFi Wealth LLC and SoFi Securities LLC offering investment products and services. Robo investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser. Brokerage and self-directed investing products offered through SoFi Securities LLC, Member FINRA/SIPC.

For disclosures on SoFi Invest platforms visit SoFi.com/legal. For a full listing of the fees associated with Sofi Invest please view our fee schedule.

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