Screw my Roth (yeah I just said that)

December 5, 2012 · 70 comments

When I graduated college in 2007 I promised myself I would fully fund my Roth IRA every single year. We are in 2012 now, and so far, I’ve stayed true to my word. BUT NOT FOR LONG. One of my resolutions for 2013 is to STOP contributing to my Roth IRA.

That’s right, I’ll probably never contribute to my Roth IRA again. Like ever.

If you’ve read my blog for a while you’ll have seen many a posts where I confess my undying love for Roth IRA’s, like this one six weeks ago. The more I think about it, however, the less convinced I am that it’s the right place for my money.

Girl Ninja and I are in the 25% tax bracket. Looking at historical averages, we will likely remain in the 25% tax bracket for a very long time, likely our entire working lives. I could nearly double my already decent salary, and we would still be in the 25% tax bracket.

What’s more, I don’t necessarily think the government will attack the middle class anytime soon. Politicians argue about the richest and poorest people in America, not us middle-classers. Republicans want to cut entitlement programs, and Democrats want to tax the wealthy. That’s the way it’s been, and the way it will continue to be. When’s the last time you heard someone run for president say “I want to stick it to the middle class”?

Let’s say the government does get greedy though. My taxes could theoretically go up at some point in the future, but guess what, Roth IRAs could also be taxed at some point in the future. Roth IRA’s were made for the middle class. Literally. (A single person making more than $125K and a married couple earning more than $183k aren’t even allowed to contribute to a Roth because, by the government’s standard, they make too much.)

So if the government would wage war on the middle class by increasing their income tax obligation, why wouldn’t they wage war against the middle class by taxing Roth IRAs? Heck, they’d likely go after the Roth first since that would only piss off a portion of Americans (those who actually have a Roth) as opposed to enraging the entire middle class. (note: I don’t think the Roth will be taxed at any point, FOR THE SAME REASON I don’t think middle-class taxes will increase, it would be political suicide).

If taxes aren’t likely to increase for the middle class, and I have no reason to believe I’ll be in a higher tax bracket come retirement, I see no benefit to a Roth IRA.

Why give the government more than I have to?

Last night, I logged in to my 401k plan and upped my contributions by exactly $6,667 annually (this pretax amount is equivalent to $5,000 after taxes…the amount I would have put in my Roth). This increased my 401k contributions from 8% to 16%. Who knows, if I’m feeling crazy I might even try to max it out to a full $17,000 annual contribution.

I don’t hate my Roth. I’ll continue to let what money is in there grow tax-free, but I’ll probably never contribute to it again.

And regardless of the things I’ve said in the past, you might want to consider kicking your Roth IRA to the curb as well.

To further prove the point here was a blurb from a comment below:

“If you are in the 25% tax bracket and contributed $100 to a Roth IRA and it grew 10% you would be able to withdraw $110 tax free (let’s ignore the 5 year rule etc). For the 401k if you contributed $133.33 (which works out to $100 pretax: $100 / 0.75) and it also grew 10% you would have $146.67, and after paying 25% taxes it would give you $110, which is the exact same as the Roth IRA.”

p.s. If you want to disagree with me, or call this decision stupid, use MATH to back your claims up. If my tax bracket is not higher in retirement, the Roth benefits are significantly diminished.

{ 70 comments }

1 StackingCash

I’m confused. A Roth IRA is tax free in the future, so if you have 2 million in your Roth IRA, you can take it out tax free. How is that bad? Your 401k will be taxable income once you start taking it out in the future, which seems sucky to me.

2 Ninja

See my response to Jessica below :)

3 Jennifer

I could see the government eliminating the Roth IRA option altogether in the future, but I don’t believe current investments will ever be taxed. I will keep maxing mine out as long as its available to me.

4 Larry

Jeez. Another blogger recently started speculating based on no evidence whatsoever that the greedy government might someday be taking away his 401(k). Better head for the hills; nobody or nothing is safe. I don’t even know what you mean by the government “waging war” against the middle class; if anything has been agreed on by both parties, it’s to keep middle-class taxes low.

All of these speculative assumptions completely ignore the slowness of change within the federal government and the constant push and pull of forces in our political system. It took fifty years to enact some kind of federal health care legislation that apparently still satisfies no one. A proposal in 2004 by Bush Junior to partly privatize Social Security went nowhere. And yet you’re willing to stop contributing to your Roth IRA, perhaps the most advantageous retirement vehicle yet devised, based on some totally theoretical assumption.

5 Ninja

Larry, I DONT think the Roth IRA will be taxed by the government in the future, for the exact same reason I DONT think taxes will raise much (if any) for the middle class. You said yourself…

“if anything has been agreed on by both parties, it’s to keep middle-class taxes low.”

If I am NOT in a higher tax rate come retirement, the benefit of the Roth IRA is non-existant. And if I am in a lower tax bracket (very likely) then the 401K is a clear winner. All I was saying was that if people think the government is going to get so greedy they significantly increase taxes on the middle class, they could start doing some other crazy stuff like taxing the Roth. Never said I actually think that will happen….because I don’t.

p.s. I might be making the most money I ever will right now. Girl Ninja is gonna quite working here in the next year or two when we have kids. It could take a long time for me to increase my income to compensate for that loss.

6 Chris

I have to agree with the general sentiment here. This is a pretty silly blog post. I agree or at least can understand where you come from on 90% of your posts but not this one.

The 401K and the Roth are mutually independent vehicles for retirement. They are part of a tool kit that includes cash savings, social security, brokerage accounts, home equity, etc… Saying the Roth is dumb because you’re tax bracket isn’t going to change is very short sighted.

So now you’re contributing 100% to your 401K and what if that grows to be 2 million by retirment? You’re future value would be 1.5 million. I would rather have 1 million in my Roth (tax free) and 1 million in my 401K and take the extra 250K. The tax up front (by not getting the deduction on the 401K contribution) will not exceed 250K over your life time.

7 Larry

ITA with your point about the “tool kit,” and would make it more strongly. We’re obviously in a retirement crisis in this country now. People are living longer, which is placing more strain on both social security and the health care system. When SS was originally enacted, it was intended as a supplementary vehicle to one’s own savings, and the average life expectancy was only a few years following retirement. Now people can expect 20-25 years in retirement, at a time when many have saved almost nothing. As it is, pension plans are becoming less common, social security is under attack from some quarters, and the only thing that’s left is one’s personal retirement funding with all the tools from your tool kit. That being the case, the likelihood that the government will start plundering individual retirement accounts of any kind seems to me infinitesimal.

8 Ninja

It’s not silly if you run the numbers man. Seriously do it and you will see. You are basing a decision off of emotion, not numbers. Check it…

“If you are in the 25% tax bracket and contributed $100 to a Roth IRA and it grew 10% you would be able to withdraw $110 tax free (let’s ignore the 5 year rule etc). For the 401k if you contributed $133.33 (which works out to $100 pretax: $100 / 0.75) and it also grew 10% you would have $146.67, and after paying 25% taxes it would give you $110, which is the exact same as the Roth IRA.”

9 Shane

Assuming taxes stay even a 401k is equivalent to a Roth IRA, but by favoring one over the other you are making an assumption that either your taxes will be lower or higher. It could go either way taxes could go up or they could go down. For those who think they will only go up you have to take into consideration a tax code change of say a national sales tax which could make income taxes go down.

I personally prefer that not all my eggs be in one basket so I contribute to both. No one knows what the future holds… deversify.

10 Emily @ evolvingPF

You should increase your contribution to your 401(k) by $6.5k or so because of the tax deduction you’ll get.

I’m satisfied contributing to my Roth for now since we’re in the 15% tax bracket and don’t anticipate being there for too much longer. Even in the 25% (28%?) tax bracket I’ll probably still contribute before- and after-tax. Who knows what taxes will do in the future – I’ll hedge.

11 Ninja

Good catch. I’ll make that change tonight :-) thanks!

12 dreemsie

You should have been working to max out your 401k from the start and then moving into your Roth.

Does the government off you a Roth 401k? We have both the regular 401k and the Roth 401k.

13 Angela

Isn’t one of the big benefits of a Roth IRA that its earnings are also tax free when you withdraw them in retirement (not just the after-tax money you originally contributed)? And I believe earnings in a 401(k) are taxable when they are withdrawn. So isn’t that a pretty good reason to stick with the Roth IRA? Or am I missing something here?

14 Jessica

That is exactly what I was thinking too. Ninja, did you forget that with a Roth IRA, earnings dispersed after age 59 1/2 and after being held for at least 5 years are not taxable? All earnings from your 401(k) will be taxable… so I feel like if you do the math, the Roth IRA is going to be a better investment as long as you’re still able to contribute.

15 Jessica

I guess if you do the math, the outcomes will be identical… (assuming you’re in the same tax bracket at retirement as you are now.)

16 Ninja

EXACTLY! I really am not crazy. I’m realistic. I’m in the 25% tax bracket right now. No reasonable retirement projections lead me to beleive I will have SOOOO much money come retirement that I will be withdrawing enough to put me in the 28% tax bracket. If I stay in the 25% tax bracket come retirement it is a wash, the Roth and the 401k have the same advantage. If I am in a LOWER tax bracket come retirement (which is likely since I wont be making money, and my expenses will be less since I wont have a mortgage/rent/dependents) then the 401K is a winner.

People can tell me I’m being emotional. That I’m crazy. Blah, blah, blah. But no one has backed it up with actual numbers. Someone, anyone, tell me they are CONFIDENT I will be in a higher tax bracket. And if you don’t think I will be, then tell me why I’m dumb for neglecting a Roth.

I think people are crazy for assuming they are going to be in a HIGHER tax bracket once they stop working.

17 Jessica

Maybe you could make a little comparison chart and put it in your post above so that people can see that the outcomes will be the same if you are still being taxed at 25% in retirement, and how you would actually come out ahead if you were being taxed lower than 25% in retirement. That might help make your point.

18 czsea

To add an additional wrinkle – if Congress/the President ever agree to implement some type of tax reform lowering rates and closing loopholes (eliminating deductions), previous 401(k) contributions would be even MORE valuable (because you deducted 25% or more on the way in, and you would be taxed at a lower rate on the way out)!

I think anyone who is in the 25% bracket (or higher) should be first maxing out 401(k) contributions, and ONLY then contributing to a ROTH (assuming they are eligible – not over the income limit).

Anyone in the 15% bracket however, may likely be better of in a ROTH, if they expect to make more money in the future.

19 czsea

Actually, I would add another advantage to the 401(k) column – if you live in a state with income taxes, your 401(k) contribution lowers your state taxable income (worth 4-10% of your contribution amount depending on the tax rate your state). Then, when you leave your job and retire, you could move to a lower % (or zero %) income tax state (there are 7 or 8 zero % states I believe, including Washington, Florida and others). You would get no benefit from a ROTH by moving to a lower income tax state, but I suppose it would enable you to move to a higher income tax state (who would want that?).

20 Petunia 100

“if you live in a state with income taxes, your 401(k) contribution lowers your state taxable income (worth 4-10% of your contribution amount depending on the tax rate your state). ”

Maybe, maybe not. States make their own income tax laws, they are not required to conform to federal income tax laws. California, for example, did not allow IRA contributions to be deducted for many years (they do now).

21 becca

A) Tax rates are lower now than they’ve ever been except for during the 1920s, right before the great depression. It’s not certain they’ll go up, but statistically…

B) It’s political suicide to tax retired people when there are proportionately a lot of voting retired people. No more baby boomers? It likely will become politically advantageous to tax retired people more. It depends on where you are in the underlying demographic trends. Depressingly, “kicking grandma when she’s sick” is not inherently politically toxic.

Because of A), I think taxes *should* go up, thus I have trouble objectively telling whether planning for them to go up is a good idea. While I can’t be CONFIDENT your personal rate will change, I would wager it far more likely than not that taxes in general will increase.
Also, just as others have pointed out and you may wake up and find yourself a millionaire when your site takes over the internet, you may wake up and find yourself bankrupt over a medical crisis. It’s not “selling yourself short” to hedge bets for both your future and the future of taxes by having both a 401k and a Roth.

22 Ninja

I went back and looked at tax rates and if you adjust for inflation we have always been and will most likely always be in the 25% bracket. If we were at the very upper end of the 25% bracket then maybe id give this some thought, but we aren’t. We are right in the middle.

23 becca

Percents should not be adjusted for inflation.

The 25% tax bracket as you understand it goes back to 2003, which is not terribly long. I am not disputing whether you’re likely to stay in a middle income taxable range, I am pointing out that the ENTIRE tax structure can change. We’ve had as many as 55 brackets and as few as 2. If we went back to 55, we’d all have a heck of a time estimating whether we’ll be in the same tax bracket as contributors or as retirees. But even if we keep 6 brackets, you personally could be in the same one relative to other people, and your rate can still increase. Simply allowing the Bush tax cuts to expire (which is currently the default path for Washington) will increase your tax rate. Basically, you are looking at 9 years of data (Bush tax rates), and assuming that you can use that to predict 40+ years of future tax rates. This is not the most effective way to use the information that is available to you- you could at least look over the history of tax rates and conclude that over any given lifespan (40+ years), the tax rates are likely to change.
Based on the fact that over 40+ year periods taxes have always changed, and that they are now lower than they usually are, I anticipate they’ll go up.

24 Larry

Forget brackets for the moment, and let’s suspend any mutual accusations about who’s emotional or dumb or crazy and the like. Furthermore, let’s assume (absent any evidence otherwise) that all the IRA and 401(k) rules remain the same until 2050, when you’re 65 or so.

Let’s say also you have both a 401(k) which you’ve rolled into a tax-deferred IRA, as well as a Roth IRA. By age 30, you have contributed perhaps a total of $20K to each account, and in each account you have purchased the same mutual fund that grows over 40 years (when you’re 70) to $100K.

At age 70.5 you must start withdrawing from your tax-deferred IRA, and you will have to pay ordinary income tax on any withdrawals.

At age 70.5 you have no withdrawal requirement from your Roth, and if you do withdraw from it you never have to pay a dime of addtional taxes.

Now help me out please and tell me why you would not prefer the Roth.

25 Ninja

Because I am saving for retirement so I can use that money when I retire. Not let is fester and collect dust indefinitely. What’s the point of contributing to a Roth if I’m not gonna use that money till in too old to enjoy it?

26 Larry

Who’s saying anything about it festering and collecting dust? Of course your Roth IRA is for retirement. But to continue my example (assuming you eventually withdraw all the money from both the t-IRA and the Roth): if you withdraw your entire $100K from the Roth, you will have had to pay taxes on $20K. You will have amassed $80K that’s 100% tax-free. If you withdraw your entire $100K from the t-IRA, you will have to pay taxes on $100K.

27 Mark

Larry, you’re right here but only because you’re comparing the Roth IRA to the Traditional IRA, since each has a $5000 maximum contribution ($5500 starting in 2013). It looks a lot better in your example because you’re comparing contributions of $20k after-tax Roth dollars with $20k pretax Traditional dollars ($15k post tax in 25% bracket).

In your example, the Roth contributions of $20k grew to $100k, which is the final after-tax value. If you contributed $26,667 to your Traditional 401k ($20k post tax in 25% bracket) which would grow to $133,333 using the same growth rate, then you should still have $100k after taxes assuming you stay in the 25% bracket.

The entire discussion really comes down to if you’ll be in a higher or lower tax bracket when you retire. My personal plan is to max out my 401k as I continue to earn more money while being employed. I personally believe my expenses will be much lower in retirement without the need to pay a mortgage and not wanting to go out as much. If I do end up becoming extremely rich, I would put a significant amount of my taxable investments in municipal bonds since the interest does not increase your AGI. This would ensure that you still can earn lots of interest through your taxable investments to live on while also taking the required distributions from your 401k at a lower tax rate.

28 Ninja

And I don’t think it’s unreasonable to assume ill be in the same or lower tax bracket when I retire. That is the crux of this discussion, and cannot be ignored.

29 Larry

I’m not ignoring it, Brandon. My example stands no matter what your tax bracket is. You still haven’t answered why you’d prefer to pay tax on $100K when you can pay tax on only $20K.

30 Ninja

Because your math is wrong.

You said “assume you contribute $20K to both Roth IRA and to 401K” and let them grow to the same $100,000 benchmark.

That is your flaw. You can’t make $20k to a Roth equivalent to $20k in a 401k. It would take $26,000 in income ($20k/0.75) to contribute $20,000 to a Roth. So you would be contributing $26,000 to a 401K to EQUAL a $20,000 Roth contribution. Do you see your error now?

p.s. I made this error in my blog post as I orginally said I upped my contribution by $5,000 to compensate for the Roth. Realized my error and changed it to a $6,250 contribution so everything stays equal and fair.

31 Mark

Just a quick note Ninja, it’s actually $6,666.66 to get the 25% post-tax equivalent of $5000. Think you might have done 5k * 1.25 instead of 5k / (1 – .25).

Glad to see you switching your mind on the Traditional 401k!

32 Ninja

Ahhh, good catch! Thanks for communicating things I can’t :)

33 Larry

Allow me some time to think about this. This is turning into an interesting discussion.

(FWIW: I have a small Roth myself, and most of my retirement funds are in the tax-deferred side. I’d say my Roth is about 1/20th the size of my tax-deferred. And I think of the 401(k) and the t-IRA as roughly equivalent, since at age 59.5 you can do an in-service rollover from the 401(k) which allowed me to consolidate all my retirement savings in the t-IRA. I did not want to do a conversion to a Roth IRA because I couldn’t have afforded to pay the taxes all at once. As I do expect my bracket to be lower after retirement, I’d prefer to pay the taxes annually rather than a lump sum.)

34 Ninja

Yeah man. Trust me I was racking my brain for days. I loved the Roth, you know that, but the more I crunch the numbers and weigh the pros/cons I just don’t think it is as great of a gig as I once did. Would I call someone stupid for using the Roth, not at all, it’s a heck of a lot better than doing nothing.

That said, the universal rule of PF Blogs is contribute to company match in 401k, THEN fully fund Roth. I’m learning that, although that advice is popular, it may not be the smartest.

and we’ve reached the maximum comments allowed in a single thread so this discussion will have to continue below. Look forward to your insight after you’ve pondered it a bit more.

35 Jessica

I’m not sure I’d change my financial plans based on “what-ifs”. I think it is possible that in the future the government may change the retirement vehicles offered, but I doubt they’d suddenly tax something that’s already taxed. If they did, it’d have to be lower than the taxes you’ll pay on the 401(k) because you’ve already paid some! More likely, they’d grandfather it and come up with something new.

I’m with Jennifer, I’m going to keep adding as long as it’s there.

36 Mark

Hey Ninja glad to see you’re starting to favor the 401k over the Roth now! I agree with Emily above that you should actually increase your contribution by $6,666.67 which equates to $5000 post-tax in the 25% bracket. I loved the Roth when I was in the 15% bracket, but now that I’m progressing in my career I’m heavily leaning towards the 401k over the Roth as well. I don’t think they’ll ever actually tax the Roth IRA distributions, but they may eliminate it going forward (some people cite Social Security taxes as a reason why this might change, but for SS the government never promised it wouldn’t tax it unlike the Roth).

I think there’s a lot of misconceptions on the Roth vs 401k based on the comments I’m seeing. First of all, both accounts are great based on the fact that you get some sort of tax advantage; no taxes on Roth IRA earnings and tax-free contributions for the 401k. If your tax rate stays the same during your working years and retirement years, the 401k and Roth IRA will produce the EXACT SAME values. Ninja is banking on the fact that he’s in the 25% bracket now, and he may be in a lower tax bracket during retirement.

If you are in the 25% tax bracket and contributed $100 to a Roth IRA and it grew 10% you would be able to withdraw $110 tax free (let’s ignore the 5 year rule etc). For the 401k if you contributed $133.33 (which works out to $100 pretax: $100 / 0.75) and it also grew 10% you would have $146.67, and after paying 25% taxes it would give you $110, which is the exact same as the Roth IRA.

You can see above that if your tax rates don’t change at all then you will get the same balances. The Roth IRA is nice because you have so much liquidity (can take out all contributions as well as $10k earnings for buying a house and other qualified reasons), but the 401k is nice because you get an immediate tax break. I’m in the same camp as Ninja because although I think taxes will be higher in the future, I still believe I will have a lower tax rate since I won’t need as much money in retirement (no mortgage, heavy drinking at the bars, etc). Hope this helps clear things up about why Ninja is choosing the 401k!

37 Larry

I hear where you’re coming from, and in general if your tax rate in retirement is higher, the Roth is preferable; if lower, you would prefer the traditional. That was in fact the main rationale for tax-deferral for the traditional 401k or IRA – the assumption that you would be in a lower bracket in retirement because of lower income. If your tax bracket remains the same, then there is no advantage either way.

Set against this, however, are such factors as: 1) earnings from a Roth are tax-free when you retire, whereas they are taxed at ordinary income from a traditional IRA or 401k; 2) there is no required minimum distribution with a Roth; 3) there is no age limit for contributions with a Roth if you still earn income.

For those reasons, I like having both kinds of account; you can justify keeping both as a kind of tax diversification.

38 Ninja

Mark, I love you.

39 Matt

Yikes. Sounds like you went over the fiscal cliff. :)

40 Brian

I would continue to contribute to a ROTH to avoid required minimum distributions. I like the idea of knowing that I could pass on money to my heirs (if they are lucky) and they wouldn’t be subject to RMDs

41 Ninja

Meh, I’m not necessarily planning on just gifting my children millions of dollars, nor do I plan to be gifted millions in my middle years either. Noble for sure, but I’ll probably spend a good chunk of my retirement on living it up, spoiling the crap out of people, and ultimately giving away what’s left as I’m on my death bed.

42 Johnny @ Our Freaking Budget

Sounds like Mr. Roth (Dave Lee, of course) messed with you for the last time.

Really interesting analysis. I agree with a lot of what you’re saying, but I don’t think you be resigned to the fact that you’ll always and forever be a 25%-er. Don’t sell yourself short. And you’re right, middle-class tax brackets probably won’t shift too too much, but government is already redefining what a “millionaire” is ($250,000+), so I don’t think it’s totally out-of-question to see Uncle Sam redefining what “middle-class” means.

43 Ninja

If I was a 28%er I would start phasing out of being eligible for a Roth.

What’s more it doesn’t matter if ill make more later in 30s, 40s, or 50s. It matters what I pay in taxes now, as opposed to what I’d pay in taxes during retirement.

I’d have to be pulling $145,000 a year out of retirement to end up in the 28% tax bracket. Highly unlikely ill need that much, considering I will have my house paid for and no dependents at that point. Especially when I’m currently living on $105k.

44 StackingCash

I’m a little dizzy, but I think I get the gist of what most of you are saying. I guess I would be the one who pulled out my 2 million out of my Roth all at once to live it up instead of pulling just enough to keep under the tax radar each year. I would hate to have all my money locked up because of that reason alone. Wouldn’t you agree?

I also agree with Johnny that you might surprise yourself and make beaucoup bucks in the future and getting taxed like the millionaire you will eventually become :)

45 Ninja

If I do make the big bucks at some point, its even more of a reason to up 401k contributions. Roth IRAs just aren’t that great for people in the 25% tax bracket an higher.

46 Brian

I guess, for me at least, one of the major reasons I prefer my ROTH (or a traditional IRA if you want to go that route) would be choice. My 401k options are really limited and a many of them have insane management costs. I can avoid most of that by investing in an IRA. Even if I started making more money I would probably not max my 401k and would just keep plowing it into my taxable account for ease of access in a pinch.

47 Ninja

This is a legit reason and one I can’t argue with. If you are getting screwed by fees from your 401K investment options then a Traditional or Roth IRA might be the way to go, especially if there is no company match. Fortunately the government has some of the lowest cost funds out there (similar to a Vanguard fund) so that is not a concern for me.

48 krantcents

I Agree with you, but I just hedge my bet by funding my Roth. I can handle the savings and there is no real downside.

49 dg

The handful of funds in our company 401k are pathetic to say the least. So what a roth does, is give me the flexibility to either invest in really low cost index funds (and get returns tax free) or simply invest in stocks or ETF’s which my 401k does not.
So comparing even a simple index fund which has an ER of 0.2 with vanguard to a similar one in my 401k offering which has an ER of 2.08, if i compound that over 30-40 years on 5k a year, that adds up quick :)

50 Larry

I assume you’re not yet 59.5, but once you hit that mark, the IRS allows you to shift the funds from your 401(k) into a tax-deferred IRA with no tax consequences – meaning the funds retain their qualified status. This is a little-known provision and is not allowed by all 401(k) plans, or is allowed by some with restrictions. My company’s plan allows this so-called in-service rollover without restrictions and I have already made use of it once and plan to do so again. Something to look into once you hit that age.

51 Angie

For me, the main benefit to a ROTH vs. a 401k/traditional IRA plan is the versatility upon retirement or death. With our 401k, we have to take out money once we reach a certain age (72?), but with the ROTH, I am not required to make distributions at any age. If we find ourselves with enough money from pensions, rental income and Social Security, I might just let the money grow for my kids, rather than take it out for playtime. Or if we decided to pull a massive chunk to buy a vacation home/boat/world tour, it could totally mess with our tax bracket if it’s not in a Roth.
Also, if we died before depleting the accounts, my kids would be required to start taking regular withdrawls from the 401k regardless of their ages or how it effects them tax wise, but the ROTH could continue to grow for their retirement or anything else they wanted without them having to pay taxes on it.

52 Ninja

Wow, you are a super nice parent. I just don’t think I really desire giving my kids a few million when I die. Would I like them to be taken care of? Sure. But I don’t want them to just expect millions when mom and pop pass away. I’m more likely to give them a set dollar amount, and donate the rest.

Not to mention the minimum distribution age for a 401k is 70.5. That’s pretty freaking late if you ask me. I can’t possibly fathom a situation in which I plan to not need any of my investments until after 71. Why would I wait to pull from my Roth until I’m 75, in probably the worst physical health in my life, and about to die? No way jose. I want to enjoy my money while I can, in my 60′s while I still have a little pep in my step.

53 Larry

I can’t possibly fathom a situation in which I plan to not need any of my investments until after 71.

You may have a fulfilling and lucrative career at that time from which you have no wish to reitre. My old friend the law professor Ralph S., who unfortunately just died at 68 from complications of diabetes, always told me he never planned to retire and would die teaching. (It didn’t quite work out that way.)

Why would I wait to pull from my Roth until I’m 75, in probably the worst physical health in my life, and about to die? No way jose. I want to enjoy my money while I can, in my 60′s while I still have a little pep in my step.

Why assume you will be in bad health at 75? My parents are 86/91 and are still active, though naturally slower than in their middle age. People are living longer than ever. The great American composer Elliott Carter recently died at 103, and was writing music until a few months before his death.

54 Ninja

But what about the fact that the mojority of Americans find themselves in lower tax brackets when they retire? I just read the other day, 60% of those 50+ have less than $100,000 to their name in retirement.

The reality is, for the MAJORITY of Americans the Roth is a bad deal because they will end up in a lower tax bracket when they quit working. So at the very least, the Roth IRA is misleading, when considering the way things work out for the typical person.

Obviously for someone like you, or me, that has been disciplined in saving for retirement, then one could run in to a situation where they wind up in a higher (or the same) tax bracket come retirement, but sadly that’s just not the case for 75%+ of the population.

55 Petunia 100

I think it is best to have both.

The Roth has flexibility. It can double as part of your EF. If you are doing any taxable investing, it can shelter some of that income. If you have a nice low rate mortgage and want to pay it off early, it can make sense to send your prepayments off to your Roth instead (where it will grow tax-free and quite possibly at a greater rate than your mortgage) until the day you have enough to pay the mortgage in full.

One day a few years ago I was thinking about what life would be like in retirement with all of my money in a traditional IRA. I intend to use tax-deferred money for regular income, withdrawing at the rate of 4%. What if I need a new roof to the tune of 20k? Well, I’d be forced to pull from tax-deferred, pull extra for the income taxes, and accept that my income had just permanently decreased. I don’t like that plan very much. So, I decided to start tucking money into a Roth as well, in order to have a source of funds I could touch without owing taxes or reducing my monthly income.

Why limit yourself to only one or the other?

56 Ninja

Hmmm, while what you say is true I think it is kind of unfair. The purpose of a Roth IRA is for retirement, not emergencies.

One could take your argument and flip it. Something like, Roths are bad because the contributions can be pulled at any time and people are more likely to raid it than they would a 401k since they know a 401k will result in harsher penalties.

An emergency fund is for an emergency, and a Roth is for retirement. At least, for me it’s that way.

p.s. I have $33,000 in my Roth IRA currently. That should sufficiently cover virtually all unforeseen expenses except health issues, if for some reason I did need to pull from it.

57 Petunia 100

Will you clarify what you mean by “unfair”? Unfair to whom?

58 Ninja

Meaning you can’t have your cake and eat it too. If you pull money from your Roth it is no more than a glorified savings account. If you don’t pull money from it, it remains a retirement account.

It’s one or the other, not both.

59 Larry

After thinking this over some more I see where you’re coming from regarding the tax bracket and math situation. (Though in honesty, Mark explained it somewhat better.) But I disagree on the point immediately above. The Roth is both a savings and a retirement account depending on how you use it. Of course once you hit 59.5 and have your Roth five years, there are no penalties of any kind, and for the record I have had my Roth since about 2001 and haven’t yet touched a dime of it. It is good to know however that in a true emergency I have a backup source of funds that I can touch totally tax-free.

I agree also with some people above that the Roth still provides a number of advantages over the 401(k) – among them, the RMD thing and the greater freedom to choose the investments you want. Let’s say you have a “tool kit” consisting of a taxable account, a traditional IRA (you’re retired, and have rolled over your 401k into it), and a Roth. Between your taxable account and social security, you have more than enough for your needs; however, you hit 70.5 and you’re force to take an RMD from your IRA that reduces the amount you want to leave your heirs. With the Roth you don’t have that restriction.

60 Petunia 100

But you can, though. ;) You can enjoy the tax-free growth and use your Roth for any goal you choose. This flexibility is unique to the Roth.

61 Brianne

I think I need to go the opposite direction. I’ve been putting 15% of my primary income in my 401K to reduce our taxable income but I only put 2% of my primary income in my Roth. I should take more advantage of my Roth and try to max it out, perhaps while not reducing my 401K contributions. I like the flexibility of investing in the Roth and the ability to choose funds with a much lower expense ratio than the limited funds available from my 401K.

The standard advice (Suze Orman, et al) seems to be contribute to the 401K to get the match, then max out your Roth, then put any additional retirement savings you can afford in your 401K. My company does profit sharing rather than giving a match, so that’s really a moot point but I totally understand the logic. It’s not just about future tax rates; it’s about control.

I also like the idea of using your Roth as a secondary savings acccount. Suze lets you include your Roth savings as either a boost to your emergency fund or as part of your retirement, but not both.

62 Pam

Hmmm… I think I got confused when you said this:

“Girl Ninja and I are in the 25% tax bracket. Looking at historical averages, we will likely remain in the 25% tax bracket for a very long time, likely our entire working lives. I could nearly double my already decent salary, and we would still be in the 25% tax bracket.”

Can you point me in the direction of the “historical averages”? I’m not sure how you figured this out (although the fact that GN may leave her job, that makes sense to me). Like others, I thought the whole point of contributing to a Roth IRA when you were young is that you are paying the taxes for the bracket you’re currently in. If you’re not going to move, then I see where this advantage is lost…but I don’t see how an advantage is GAINED for the 401(k).

I’m closing in on the top end of the 25% tax bracket. Wouldn’t it make more sense for me to keep fully funding a Roth IRA, until I get pushed to 28%?

63 Ninja

The only comparison that you need to make is what your tax rate is NOW, as opposed to what you think your tax rate will be when you RETIRE. It doesn’t matter if you make more five years from now, ten years from now, or thirty years from now. You have to compare your tax bracket during each Roth contribution, to your tax bracket when you retire.

Statistically, the vast majority of Americans find themselves in a lower tax bracket when they retire, than when they were working. Think about it. When you retire you likely wont have a house payment (hopefully your mortgage is paid off), you wont have dependents as your kids will be in their 40s and 50s, you wont have any major pending transactions (no more houses to buy, college tuition to pay for, etc). Experts across the board say you can expect to live on about 70-80% of your pre retirement income when you retire.

So if you are likely going to be in a LOWER tax bracket when you retire, then you are today, why would you pay MORE taxes than you have to? You shouldn’t.

If you think you’ll be in the same tax bracket, then its a wash (but you DO get the tax benefit today as opposed to delaying it 40 years). And if you think you will be in a higher tax bracket (again statistically unlikely) then you should put $$$ in to a Roth.

I encourage you to run numbers for your situation, and do what’s best for your family. The Roth still might be a viable option, but for the majority of people, the Roth is deceptive.

64 Pam

Aha…that make sense. Interesting. Definitely some food for thought!

65 Derek

A Roth provides flexibilty in distributions; An IRA is at the mercy of current tax margins.

I have a Roth in addition to my 401k (TSP) because it allows better diversification and because I want the option during retirement to have flexible income while maintaining a lower tax bracket. I am planning to use the TSP as the main source of income and rely on the Roth to provide the variables.

What happens at 75 when you do want to buy those 2 Spanky Porsche Cayennes for you and your wife? Pull the 100k out of your Roth while still maintaining an AGI of 33k! There you go you sexy senior. Way to pimp that 15% tax bracket.

66 Ninja

This is reasonable and definitely something to consider :)

67 Brian

What about a scenario where you decide to invest in dividend paying stocks and some bonds and live off their payments. With a ROTH you would not be taxed on any of this income, where as a traditional IRA you would be taxed at ordinary income (upon withdrawal). I know many people keep dividend stocks in a taxable account since they get favorable treatment, but that might not always be.

Just another opinion, and I know not everyone wants to be in dividend producing stocks or stock funds or in bonds.

68 Devils Advocate

I would advise to fill both buckets of tax advantaged space. Max out 401k and contribute 5k to Roth IRA. If one makes more than Roth IRA income limits, backdoor Roth. Silly not to contribute max to both (if one can). If you can’t afford it, maybe you are spending to much.

69 Tess

Ninja – Do you anticipate that when you have a few children (and their tax exemptions) and if GN is not working that you may fall back into a lower bracket for some time? Maybe contributing to Roths then will make more sense.

Previous post:

Next post: