Disadvantages Of The ROTH IRA: Not All Is What It Seems
For over two years, I’ve been an opponent of the ROTH IRA after the government came out with its tricky dick way to let us all do a “one-time” conversion from our traditional IRA’s. The title of the post written in January, 2010 is called, “Be A Sloth And Don’t ROTH“.
In these two years, I’ve become a more mellow, laissez faire blogger who realizes that there’s no point trying to force my views on others if they don’t want to change. Instead, I’ve simply sought to lay out the reasons why I think the way I do, and let you readers decide.
If the choice is between NOT SAVING and saving via a ROTH IRA for your future, then the answer is that one should open up a ROTH IRA rather than piss their money away on stupid stuff that depreciates in value. However, do know that you are still pissing money away by giving some of your money to the government. And if the choice is between choosing a traditional IRA over a ROTH IRA, choosing the traditional IRA is hands down the way to go.
As you readers have demonstrated time and time again, you’re past the basics of personal finance and so am I. Financial Samurai readers are not the target audience of whether one should save or not. Of course we all must save, because eventually, we wil no longer want to work and the government might not be able to support us. We’re probably not even the target audience for the ROTH IRA since many of us can’t even contribute thanks to egregiously low income limits.
Please read the reasons why a ROTH IRA is not a good idea for many of you. If you’re still in favor, at least you know the other side of the story and Uncle Sam thanks you!
DISADVANTAGES OF A ROTH IRA – NOT ALL MILK AND COOKIES
* The government is inefficient. I’m all for patriotism, but if you think the government is efficient with your money, then you are simply not paying attention to the enormous budget deficits on a state-wide and country level. By participating in a ROTH IRA, you are paying your taxes up front, thereby giving the government more of your money to waste! Would you give an alcoholic a beer? Would you give a drug addict some meth? Would you eat a double cheeseburger in front of an obese person who is trying to lose weight? No, no, no! There is a reason why there are $2,000 staplers and $10 staples in the government bureaucracy! Why do you think the Social Security system is so underfunded? The government wastes your money, so don’t give it more.
* The government is smarter than you. The government realizes people are bad with their money, which is why they set up a withholding tax system to make sure people pay throughout the year. If it was up to everybody to pay their year-end taxes at the end of the year, all hell would break loose because people are not disciplined to put money away to meet their obligations! The country would go into instant default. As a result, the government has pushed propaganda on the masses to get them to pay MORE TAXES UPFRONT, hence the introduction of the ROTH IRA. They will spend millions on marketing to highlight why converting to a ROTH and participating in a ROTH IRA is a great idea. Yes, it’s a great idea for them, not for you!
* You allow asymmetric reward or punishment between equals. Not everybody can participate in a ROTH IRA. Only those fortunate enough to make less than $105,000 a year/$165,000 for married couples (it’s always changing). After making more than $122,000 a year for singles, you are shit out of luck! No soup for you. Sorry, but the government doesn’t believe you have the right to save in this way. Discrimination is not OK, just because you aren’t being discriminated against. We need to fight for equality for everybody! The income cap for contribution is too low. The irony is, the government is actually saving people who make more than $105,000-$122,000 a year from paying more taxes and getting tricked into entering the Borg. Unfortunately, there are income limits for contribution on an IRA as well, which are even more egregious at around $66,000 for single filers.
* The math is the same whether you pay now or later. Whether you pay taxes now and let your investment grow tax free, or you let your pre-tax investments grow, and then tax it upon retirement results is more or less the same! Don’t believe me? Do a calculation yourself. Here’s an equation: Y = A * B. Re-arrange to A = Y / B. Or Y = A * B is equal to Y = B * A. Trust me, I was a rock math star in the 2nd grade!
* What will $5,000 do for your retirement? A max contribution of $5,000 a year isn’t going to get you to the promised land. If you are already maxing out your 401K (pre-tax contribution up to $17,000), and you are eligible for a ROTH IRA maximum contribution for a single filer ($105,000 income or less), you probably will get more out of spending your $5,000 on life now. I am a big proponent of aggressive savings, however, if you are only earning up to $88,000 a year in gross income after maxing out the 401K, I’d rather you not tie up that $5,000 in a government savings vehicle until 59.5. Spend it, save it in your own investment account, or keep it liquid.
* You may never reap the fake rewards. Let’s say the math wasn’t the same, and you continue to contribute to your ROTH IRA because you believe in the tax benefits. Unfortunately, you die at age 59. You’re screwed! All those taxes you paid upfront to the cunning government, and you’ll never once get to utilize the returns on your ROTH IRA. What a shame. Guess what? Over those 37 years, the government has happily spent your tens of thousands of dollars on themselves. That makes me sick, and it should make you sick as well. But maybe not, since you are a patriot.
* Withdrawal penalty. The are no withdrawal penalties for the after tax money you contribute to your ROTH IRA. However, if you decide to withdraw money that has been earned from your after tax contributions, then will be penalized by 10% + your normal tax rate. For example, if you contribute $10,000 to your ROTH IRA and it grows to $15,000. There is a 10% penalty on the $5,000 + your normal tax rate. Just don’t be naive to put it past the government to one day tax your after-tax ROTH IRA contributions again upon exit. Look at Social Security, for example. They raised the base case age for full retirement from 62 to 67 for those born after 1960! That’s five long years more one has to wait to receive full SS benefits.
* You chop off your legs and fingers. America is a free country where we can relocate at will. If you live in one of the 43 States where there are State income taxes, then it behooves you not to pay more State income taxes. In California, our state income tax is 8-10.4% and we’ve got a huge budget deficit! There’s no way I’m giving 10% of my hard-earned retirement income to the politicians up in Sacramento to waste. Instead, once I retire, I plan to move to one of the 7 no income-tax states (Nevada, Washington, Wyoming, Florida sound reasonable), and avoid paying 10% state taxes altogether. You have the power to save on taxes just by moving.
CHOOSE THE TRADITIONAL IRA OVER THE ROTH IRA WHILE MAXING OUT THE 401K
If you are a recent college graduate who is at the beginning of their earnings power, then choosing to participate in a ROTH IRA is less egregious than someone who is older and makes more money (up to ~$122,000). It is a good assumption you will make more money in your 30′s, 40′s, and 50′s than in your 20′s and therefore pay more taxes as a result. However, even though you are in the lower tax bracket and assume to make more, go with a traditional IRA and never give more money to the government than you need to.
Do the math. Let’s say you make $50,000 a year and contribute to a ROTH IRA. At $50,000, single, with no deductions, your Federal Tax bill is estimated at around $6,250, equaling an effective tax rate of 12.5%. However, you are squarely in the 25% Federal Tax bracket. Let’s say you are hot stuff now and make $100,000, the very income edge of where you can still contribute to a ROTH IRA. Your Federal Tax bill is now around $18,900, or an effective tax rate of 18.9%. You are in the marginal tax bracket of 28% now. What’s your saving?
Your savings really is nothing, because it’s not about moving up and down the Federal Tax Brackets. It’s about what you think future tax rates will be at for income levels below $105,000, since any more and you get phased out and can’t contribute completely after $122,000! The $122,000 and below income level for single filers is the protected middle class where no politician dare assaults. The middle class is what puts politicians in office and therefore, taxes will unlikely ever go up for this income group!
To humor you, let’s do the math anyway. $5,000 X (18.9%-12.5%) = $320 “savings” or $5,000 X (28% – 25%) = $150 “savings” per year. If these savings were real, they would be somewhat meaningful, but not really. This math is absolutely wrong and therefore, the “savings” is irrelevant.
Final Important Point: If you are a middle income person who generates $122,000 a year or less for your entire life, and is therefore able to contribute to a ROTH IRA, do you really think when you retire, your income will now be more than $122,000 a year, putting you in a higher income tax bracket during withdrawal ceteris paribus? Be realistic. At today’s 10-year risk free rate of 1.65% (as of 12/3/12), you need close to $6.5 million dollars to generate $122,000 a year in income!
2012 INCOME TAX BRACKET
| Tax Bracket | Married Filing Jointly | Single |
|---|---|---|
| 10% Bracket | $0 – $17,400 | $0 – $8,700 |
| 15% Bracket | $17,400 – $70,700 | $8,700 – $35,350 |
| 25% Bracket | $70,700 – $142,700 | $35,350 – $85,650 |
| 28% Bracket | $142,700 – $217,450 | $85,650 – $178,650 |
| 33% Bracket | $217,450 – $388,350 | $178,650 – $388,350 |
| 35% Bracket | Over $388,350 | Over $388,350 |
You never want to give the government more money than you need to. We are all idealists in college and just out of college. However, once you start paying attention to what’s going on up in the various State capitols and in Washington DC, you will realize how manipulative our politicians are. If allowed, the government will take you for all you’re worth. Power is addicting and you must help fight Capitol Hill’s addiction by holding on to your own money.
You know what’s best for yourself. You have the power to make a good living. Don’t be fooled by the government and administrators who want to make money off of you. Fight on and open your mind!
Recommended Actions For Increasing Your Wealth
* Manage Your Finances In One Place: The best way to increase your wealth is to get a handle on your finances by signing up with Personal Capital. They are a free online platform which aggregates all your financial accounts in one place so you can see where you can optimize. Before Personal Capital, I had to log into eight different systems to track 28 different accounts (brokerage, multiple banks, 401K, etc) to track my finances. Now, I can just log into Personal Capital to see how my stock accounts are doing, how my net worth is progressing, and where my spending is going. The best feature is the 401K Fee Analyzer which has saved me over $1,000 in annual portfolio fees I had no idea I was paying! There is no better tool online that has helped me reach early retirement. It only takes a minute to sign up.
* Refinance Your Mortgage: If you are a homeowner and you have not refinanced in the past year, I strongly suggest you check online to see what the latest rates are. There is seriously some serious mortgage interest savings to be had! I always check with Quicken Loans because they are fast, quick, and provide a no obligation real quote based on the input you provide. I recently refinanced to a 5/1 ARM for 2.625% in the Summer of 2012 after just refinancing in the fall of 2011 for 3.125% from 3.625%! I am now saving $4,000 a year in mortgage interest!
* Check Your Credit Score: Everybody needs to check their credit score once every six months given the risk of identity theft and the fact that 30% of credit scores have errors. For over a year, I thought I had a 790ish credit score and was fine, until my mortgage refinance bank on day 80 of my refinance told me they could not go through due to a $8 late payment by my tenants from two years ago! My credit score was hit by 110 points to 680 and I could not get the lowest rate! I had to spend an extra 10 days fixing my score by contacting the utility company to write a “Clear Credit Letter” to get the bank to follow through. Check your credit score for free at GoFreeCredit.com and protect yourself. The averaged credit score for a rejected mortgage applicant is 729!
Regards,
Sam
Hey Irene-
Stop with the you owe me attitude. No one is against helping those who truly need it. Ask and show gratitude. Others give out of concern and brotherhood, not just bk you demand and demean. Poor judgement on your part to say America will be better off without earning taxpayers. That is like you killing the goose that lays your golden egg. Think Girl and while your asking how about asking for a job…like the Chinese proverb, you know, learn to fish and feed yourself instead of asking to be handed one meal at a time. Then you can practice what you preach by giving it away freely to someone who doesn’t have foresight or any appreciation. Come on now and do the right thing ’cause thats what you want others doing for you.
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I just turned 25, make 100k a year, will max my 401k for 2012 with my next paycheck, opened up a brokerage account to pick up some stock in a few of my favorite companies this year, and also opened up a ROTH IRA at the same time. I made a 5k contribution to the ROTH account in April and felt I was doing the right thing until I stumbled across this article and began to doubt my decision. Since then, I’ve been hooked on financial samurai articles and have read through far too many comments. In regards to my situation, I think it makes sense for me to contribute to the ROTH IRA. Unless I am mistaken, a traditional tax-deferred IRA is not an option for me as I am making 100k a year and contributing to a 401k. In my case, the only options are an after-tax IRA or ROTH IRA. The ROTH IRA makes the most sense in this case as the earnings would grow tax-free. Am I missing something, or is this correct? I was confused from the example in your article of the ‘hot stuff’ making 100k, or the ‘Final Important Point’ of people on the income edge because wouldn’t someone in that situation typically be unable to contribute to a traditional IRA? In those scenarios, contributing to a ROTH IRA makes sense but the article seems to casts a negative light on it.
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Financial Samurai Reply:
December 6th, 2012 at 9:39 am
Hi Shawn,
Thanks for stopping by. You are doing GREAT and if you keep it up for the next 10-15 years, you are going to have tremendous optionality to do whatever the hell you want in life! Trust me when I tell you that even the most exciting thing gets boring after a while, so you want to have the financial freedom to do something new. I know I did after 13 years working in finance.
You are correct regarding a ROTH IRA given your income is over 100K/year. Darn the gov’t for discriminating against those making six figures! So definitely feel free to max out your ROTH IRA and 401K. Contributing to a ROTH is better than not contributing.
Finally, I strongly suggest you sign up for Personal Capital, an online wealth management company that is free for users. You can track all your accounts in one place so you can have a better handle of your finances. It comes in handy the more accounts you have, and the more your wealth grows! Before PC, I had to log onto 7-8 different institutions to track 25+ different money accounts.
Best,
Sam
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Shawn Reply:
December 6th, 2012 at 10:15 am
Wow, I wasn’t expecting a reply so fast. Thanks for your comment Sam.
I’m currently using mint.com to track my various financial accounts at a high level, but I will give Personal Capital a look. Mint is not that great at tracking investments so I’m open to other options.
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Financial Samurai Reply:
December 6th, 2012 at 10:24 am
No problem. I’m pretty responsive to questions and comments here. Mint is OK, but it’s not as good for tracking investments I’ve found, as have others.
neil Reply:
April 24th, 2013 at 12:43 pm
Shawn,
You are obviously very gullible. This article is a waste of the bytes it is taking up on this site. Unless of course it was meant to lend a bit of comedy. I’m sure the “samurai” will delete this post. But realistically, the reasons he poses for not doing a roth are laughable at best. Case in point, “After making more than $122,000 a year for singles, you are shit out of luck!. . . Discrimination is not OK, just because you aren’t being discriminated against. We need to fight for equality for everybody! “. What does that even have to do with investing. Investing is not about equality. Unfortunately it is not going to be equal. Someone always has to lose for someone else to profit, otherwise everything would essentially be free.
If you don’t think effective tax rates will be higher when you retire (which is the point of doing a Roth) you are kidding yourself. They are already on the rise, and will continue.
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Financial Samurai Reply:
April 24th, 2013 at 1:34 pm
Tax rates increased for individuals making more than $400,000 and stayed the same for everyone else. Folks making over $122,000 can contribute to a ROTH, so contributors haven’t seen any tax rate increase. Please use your head.
I’m impressed you think you will make more money in retirement than while you are working. I wish you good luck and the country appreciates you paying more taxes to support the system so we don’t have to.
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HI Sam, I am in a unique situation…I am 50 and am no longer working due to disability; I receive a small amt of income from a combination of Social Security and private insurance benefits (about $24K a year) plus about $15K in interest and dividends from investments I have. When I stopped working in 2004 I rolled my meager accrued pension of $19K over as a lump sum into a Fidelity IRA and have since transferred it to TD Ameritrade in a standard IRA account. It is now worth about $25K. I am fortunate enough to have come from a saavy investing family and will be receiving about $1 million in a trust this month and eventually when my parents pass away (if the gov’t hasn’t confiscated all their wealth) will inherit about 2 million more (sometime in the next 1-20 years since my parents are both in their mid 70s right now) . My question is whether I should put that $25K into a Roth at this point when I am in the 25% tax bracket, pay the upfront tax on it (yes I do HATE giving the gov’t my money but at least I’m getting some of it back through my disability payments…) and then work to make it grow tax free until the forced withdrawal starts in 20.5 years when I am 70.5. I am almost certain to be in a higher tax bracket down the road because of income from investments so doesn’t it make sense for me to do that ? Thanks for your input…
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Financial Samurai Reply:
December 6th, 2012 at 1:17 pm
Julie,
I would say definitely pay that tax upfront then. If you stand to inherit millions of dollars, then worrying about taxation on $25 shouldn’t be a big deal.
I would spend time spending as much time with your parents and frankly helping them spend their money and enjoy life for everybody. If you inherits $2 mil at 70, that’s great but suboptimal.
How’d you find my blog btw? Always happy to have new readers.
Sam
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Julie K. Reply:
December 7th, 2012 at 10:09 am
I found it by googling “cons of Roth IRA” and the rest is history! Very helpful because I just couldn’t figure out whether it was a good idea or not to do a Roth. Another question…could the money if just left in the traditional IRA be donated to a not-for-profit charity thus avoiding tax on it altogether? Or would I have to take the money out, pay the tax on it, and then donate it? If a tax free donation is possible, that might be another way to deal with it wisely. I love your advice on spending time with my parents….I am extremely grateful for their lifelong commitment to saving, investing and teaching us kids the importance of remaining debt free, never buying anything we didn’t have the money to pay for, and not becoming materialistic and greedy. We all worked through high school and I worked in college because I simply wasn’t given extra money to just blow on stuff I ‘wanted’. My two siblings and I have never carried any debt other than a mortgage, and all of us have now paid off our homes in full. With the gov’t likely to take more and more of their hard earned money in the future, my mom and dad have just made the decision to start spending more of their own money on themselves which is wonderful! They are planning on going into a really nice retirement center in a year or two and will have great care and amenities as they get older. Thanks for the advice!
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Anthony B. Reply:
December 21st, 2012 at 2:18 pm
With a Roth IRA, there are no required minimum distributions at age 70.5. This only aplies to traditional IRAs.
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Julie K Reply:
March 4th, 2013 at 6:11 pm
Thanks Anthony….did not know that….!
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Julie K Reply:
March 4th, 2013 at 6:15 pm
Hey, Sam….I did as you suggested….converted to a Roth and will be paying the taxes this April on it. I’ve done a little stock buying in it and am already up about 1500 bucks from when I converted it! Yeah! Now I have another question that I think I know the answer to, but just want to confirm. In the Roth, can I buy and sell stocks freely as often as I want and not have to pay attention to holding a stock for a year as I would in a regular brokerage acct.? i figure since that is a tax issue, it likely doesn’t apply. In other words, are there any restrictions on how frequently you can buy and sell the same stock in the Roth? I’m not a ‘day trader’ by any means, but might want to take profits from stocks that go up and buy different ones with the money as I go along.
I truly believe that Obama WILL go after the middle class’ money eventually….you actually think his goal ISN’T to reduce all of us to a peasant-like existence with a dictatorial super rich political leadership class at the top? He is wooing the lower and middle class now, dividing them against the upper/wealthy class to ensure that they continue to vote future liberal gov’t leaders into office. Once that is locked in place (with Hilary becoming the next President) then taxes will slowly creep downward in exchange for more and more (poorly run) gov’t programs. @Darwin’s Money
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Hello,
Great site. I am cashing out my retirement, taking a lump sum I am 55 dec 30. My wife and I want to take 150,000.00 and put down on a first time home purchase. I will need to use some of it for living exs. And I am just learning about ira s cd ect never had much to put away. Oh homes in our area are 550,000.00 and up what would you sugest to make the rest grow? Also I heard if purchase property within 90 days its tax free is this correct? One more thing when I take the lump sum do I have to roll it over to an ira? And to quilifie for no penities on early retirement must I end employment Dec 31 2012? If we rollover to an ira and want to withdraw? Thanks for your help this is all new to use.
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Financial Samurai Reply:
December 7th, 2012 at 6:52 am
Hi Rick,
Best to speak to a tax account for these questions. The one thing I’m worried about for you is why buy a first time house now at age 55 unless it is for 100% cash? You don’t want to take on huge debt now, unless you plan to work for a lot longer. Sam
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rick Reply:
December 7th, 2012 at 9:23 am
Thanks sam,
We took the cash out to buy a home that we in the past, wasnt able to come up with the cash for the down payment. We are looking to buy a home that our mortgage will be less them we pay for renting
We pay over 1800.00 a month for a small 2/2 apt.
Hoping this will cut down on our budget to afford to work less. But I am learning its mot as simple as it sounds jusy to tale the cash. Thanks for you info rick.
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rick Reply:
December 7th, 2012 at 9:25 am
Sorry for that type o (just to take the cash)
New follower here so i am sorry if this is redundant or if you answered this somewhere else. From this article I understand the disadvantages of the Roth IRA for the middle class. I know you are in favor of maxing out your 401k every year to maximum contribution limits. My question is on Roth 401K options for middle class and what your thoughts on this option. My company like i think a lot of companies offer employees the option in 401k to contribute to a roth 401k or traditional 401k. Thanks and have a great day!
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Financial Samurai Reply:
December 13th, 2012 at 10:26 am
Just say no to ROTH, IRA or 401K if you don’t have to pay taxes up front. Thx
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Scott Reply:
May 15th, 2013 at 6:47 am
If you are not very old a roth is a great option to save on taxes. I don’t make a lot a money from my employer (also don’t work a whole bunch!). Taxable income from W2′s after maxing out 401k is approx 30K, max out Roth, max out health savings plan. itemize my deductions, take the saver’s credit on my 1040, depreciate my rental properties for a loss = effective tax rate in 2012 of 1.2% If you spend the extra time on your taxes and make small deliberate investment decisions that are tax advantaged early on in life, then you will, over your lifetime, pay as little taxes as possible. I am trying to not pay taxes now AND not pay taxes in the future. When I am older and Financially independent, I will make each rental property my primary residence for a coupla years and travel the world, sell the property as my primary res and repeat. By then most of my liquid assets will be within our Roth IRA’s with the rest in the 401ks. I would have no problem paying extra taxes throughout my life if I saw it as a good investment and the gov’t using my dollars effectively. until then, minimisin’ my taxes baby!!
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I feel a bit out of my league here even writing this question.. But here goes. I am 28 and finishing my masters in Norway. I graduated at 22 from my undergrad and took a few years to work and save before pursuing a graduate degree. My tuition is 100 percent free in Norway and I am able to work part time to support myself with a salary of a meager 25,000 a year. While I am grateful for not having to spend the 20,000 i set aside originally for grad school between the ages of 22 and 25, I am plagued with feeling behind in where I’d like to be by 30. I have minimal expenses here, but my earnings as mentioned, are meager. Do I invest My max 5,000 in a roth this year as I don’t presently have the option of contributing to a 401k? Or do I wait for that opportunity and pay off some student loans from my bachelors instead and let bygones be bygones until my life stabilizes post this degree?
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Financial Samurai Reply:
December 13th, 2012 at 2:20 pm
Welcome from Norway! You still there? I think you’ll like this post about the happiest people on earth which describes your situation perhaps exactly? http://www.financialsamurai.com/2012/10/04/learning-from-the-worlds-happiest-people/
I would max our your IRA even if it is 20% of your income. Pretend it is debt you would have to pay for your master’s! You have to start somewhere!
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Hi! Just found your site and very grateful if you can answer my questions. I basically have lost everything from a divorce, except $15,000 from the equity in my home that I was forced to sell. I am now living with my brother and collecting on my Social Security (not much but every little bit helps). To supplement my SS, I am hoping to locate some part-time work. I am 65 and feel like I am starting over from square one! I am trying to stay positive and not panic. My question is where should I put this $15,000…a CD, an IRA or a sock in my closet? Seriously, it’s kind of scarey and I, also a two time cancer survivor, don’t want to be a burden on my family, should anything happen to me. I am realistic and know that at this point in my life, growing a retirement seems unrealistic, but I don’t want to just keep putting this money in a savings account that gives me nothing in return.
Any help you can give, will be greatly appreciated. Thanks so much!!
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Financial Samurai Reply:
December 28th, 2012 at 5:20 pm
Hi Leslie,
Hang in there! I would suggest you NOT lock away your $15K in a CD or anything that takes a penalty before expiration to get out. Keep your $15K in a liquid savings account where you can access ONLY for true emergencies if this is all you have left.
Definitely find some part-time work where you can to supplement SS. I am glad you are getting SS btw! It’s not a guarantee for other generations. Do you have an expertise in writing and such? There are a lot of freelance gigs online. Fiverr.com has all sorts of opportunities, and there might be things like paid surveys, being in a physical survey, etc you can do.
Good luck and hope you stick around and subscribe.
Sam
[Reply]
I would rate my financial competence about a 5 out of 10, and after stumbling on this article I am even less confident about my setup.
I appreciate the information on the site and in this article and I was wondering if you could give me some feedback about my saving strategy?
My current salary is 135k and I have a 25k yearly bonus. I am married (single wage-earner) and 31 years old, rent ~$2000/month, very low debt (Ch 7 BK around 4 years ago) and only debt is intentional to help build credit.
One thing which strikes people as odd is that I currently rent. The reason goes back to my financial competence which in the past was closer to a 2 out of 10. Some bad real estate decisions in the past when I was single/unmarried (5-7 years ago) pretty much wiped me out. I do plan on buying again – maybe in Lafayette ;) .
Setup
I have a savings account with a +1 year emergency fund, 401k being maxed/matched, checking account with Schwab (basically for the ATM reimbursements and to pay CC bill), use a Chase Sapphire Preferred Card for almost all daily/monthly purchases and memberships (goal is to build credit and earn reward points), and a roth ira at Vanguard being maxed with their target 2045.
Questions
1) I’m confused now if I should swap the roth for the traditional ira? other?
2) Should I be doing anything else with Vanguard besides automatic investments into the single target fund via my roth account? I’ve read discussions about investing in ETFs via Vanguard and I’m assuming that is just a different Vanguard account that would need to be opened?
3) Should I have a separate stock brokerage account like Ameritrade/Scottrade (or use my Schwab account) – or should I stay away from buying individual stocks because I honestly don’t know much about them?
4) Other accounts or ways you think I should be saving?
Couple of last details
I have a newborn and set her up with a standard savings account at a credit union w/ automatic deposits from my account. I’ve heard about some people buying their child gold coins regularly from somewhere like apmex.com, but I’m a little hesitant to do that. Thoughts?
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I’m 21 and I have 6,000 in a roth ira. 5,000 of it is my money and the rest are earning . I have two question . One should I still keep this account and add money to it or should I close it and use the money for something else. Two will I get penalize for taking out my 5,000 even tho its only been 3 years and not 5 yet ?
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Financial Samurai Reply:
January 4th, 2013 at 9:48 am
I recommend you keep your money in your ROTH IRA for five years and sign up with Personal Capital and track your fund for free. Start early in your life, leverage the internet, and keep up your savings. Personal Capital has this awesome Fee Analyzer which is saving me over $1,000 a year in portfolio fees I had no idea I was paying.
[Reply]
Sam,
Your section on the withdraw penalty is misleading. At 59.5 years of age, you’re allowed to withdraw ALL of your money (even the earned interest) tax/penalty free. Your failure to mention that prompted me to look it up afraid I misunderstood it.
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If the math is the same then why does it matter which account you choose to fund? Why argue against the roth if it is the same as the 401? The answer is its not the same.
Few major advantages to the roth. One you can put it in a brokerage account and buy more than just mutual funds. If over 3 year you double your money an extra time or two because youre good at investing then any advantage you had in the 401 disappears. This is also a disadvantage if you see buying stocks as gambling as your more likely to lose than with mutual funds with this approach as well. The other factor is tax rates when you make the money vs when you retire. This one is really tough to know. I dont know what tax rates will be in 30 years its tough to say.
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Great article, thanks Sam! I was just doing some research on Roth vs Traditional, and your article was very helpful.
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Hah, that picture is great, definitely embodies how I feel about the government.
I’m going to be honest, I only roughly understood the difference between Roth/Traditional IRA’s and what I thought I knew wasn’t entirely right. Thanks for breaking it down Sam. I just rolled over and I was forced to split between Roth/Traditional (no choice), at least now I know where future savings will go.
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I’m 27 and just started working July 2012. My AGI was about $36K for 2012. My employer doesn’t match 401K so I have only been contributing to a roth IRA ($3600 so far). Through April 15, 2013, I plan on maxing out the $5K contribution. I will be changing jobs next year where I will hopefully have a 401K match and hope to start contributing to a 401K at that point. What do you think of my situation right now? Should I change my game plan? Any input would be greatly appreciated.
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Confused on your equations. Scenario: 32 years old. Has $5,000 invested, and contributes $916 per month into two IRAs at 12% and stops after 7 years. At 62 (30 years):
Roth has $2,063,827.30 , only given the government (say 25% bracket) $19,235 and has full amount of 2 million to spend tax free.
Traditional has same amount, given $0 to government, but now has full taxes coming out of 2 million dollars. I don’t care what tax bracket that is, but I think it will be much more than $20,000 I think.
Even if you pulled out only the interest in the first year (12% of 2 million dollars), you will be giving the government taxes on $240,000 income. So at (just guessing at least) 35% that would be $84,000 in taxes. That is over 4 times more in just the first year of retirement in interest ALONE.
Equation 1 does NOT equal equation 2. It seems that if you want to keep money management from the government, a Roth is better.
I do think it isn’t fair that they limit the access to under a certain income range. That is wrong. I was great at math too, but I guess I did a bit better in Calculus and measuring the total under the curve…
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For all the years I’ve done my ex-husband’s and my individual tax returns, I’ve not questioned the contents in Box 5 of the 1099-R until now. I’ve read the comments on your website and want to know if I can get some or all of that money back and how do I go about doing it?
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Am I being paranoid when I think that 401Ks Roths, IRAs etc will come back and hunt us? I mean to you really think they will not tap into the last shred of wealth for middle class America some how? Even though I have a 401K I am beginning to view it as I view SS. it will not be there for me when I need it.
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Just a thought Sam. I think it would be fairly easy to get 4%/yr on average if you’re in the market. Thus it brings the necessity of $6.5M to have $122,000 income (@ 1.65% safe investments) all the way down to $3.05M to have $122,000 (@ 4% safe withdrawal rate).
Don’t forget that funding the Roth allows you tax free money that can be taken out when you want (as long as you don’t take away earnings). And I think it would be a bit easier to hit $3M than to hit $6.5M. :-)
Ps: Sorry, I keep wrestling with myself over this. Especially since my 401k is limited to mutual funds as opposed to less safe investments such as individual stocks.
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Financial Samurai Reply:
March 6th, 2013 at 9:20 am
No problem rich. Who knows the future right? What I do know is that if I pay taxes upfront to the government, I lose, they win. They’ve got my money to blow on wasteful things and I’ve got 0 chance of ever optimizing my taxes again.
Never give up. Never give up, unless you really think the government is doing a bangup job………
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Rich In The Heart Reply:
March 18th, 2013 at 11:48 am
Well, actually you have 0 chance of ever optimizing your taxes for THIS moment in time only.
Likewise, you’ve locked in your ability to NOT have to pay taxes on your money farther down the road.
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I just got my first job out of college, I’m in the 15% marginal tax bracket, and will be maxing out my Roth 401k and Roth IRA this year. Although I love your website and agree with you 99% of the time, I think we differ in opinion about the use of Roth accounts. It’s pretty simple to me, if you think there is a >50% chance that the money coming out of your account will be taxed at a lower marginal tax rate than you are paying now, then contributing to a traditional IRA/401k is more beneficial. It’s very very unlikely that I will be paying less than 15% on this money when it comes out.
Also, a couple points you tried to make don’t make much sense to me, such as:
“The government wastes your money, so don’t give it more.”
That’s the whole point of a Roth! (Giving the government a little money now to avoid giving them a lot of money in the future.) You’re not preventing paying taxes by putting money into a traditional IRA/401k, you’re just delaying payment.
also: “you die at age 59. You’re screwed! All those taxes you paid upfront to the cunning government, and you’ll never once get to utilize the returns on your Roth IRA.”
I know what you’re getting at (you might have given up spending power from the tax savings of a traditional IRA/401k during your life), but this is still irrelevant to me. Your wife or kids would get the tax free money and they would reap the benefits.
One other small advantage of Roth accounts that I think is worth mentioning, although the contribution limits for traditional and Roth accounts are the same, if you were to max out a Roth you’re effectively putting more purchasing power into a tax deferred account as compared to maxing out a traditional account because it comes out tax free.
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Financial Samurai Reply:
March 9th, 2013 at 7:34 am
Sam, congrats for getting your first job out of college and maxing out your retirement plans. If you can max out the 401k and then max out the ROTH then great. Better than not saving that’s for sure.
I think it is great you are helping support the country and America needs folks to pay taxes now to fund our burden and our older generations. I do wonder whether blogs such as mine are inadvertently hurting the government by taking away money from them and keeping more for ourselves.
Let me know in 10 years how you feel about the government and taxes. Thanks!
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6thsense79 Reply:
April 14th, 2013 at 12:22 pm
Financial Samurai,
Sam gave some very good points on the pros of the ROTH yet in your response you failed to address any of those points and gave in my opinion a thinly veiled sarcastic response. I and many of your readers would have loved to see your response to the point Sam made that it’s better to pay taxes at 15% now versus a higher rate in the future when taxes are almost sure to go up and a person may be in a higher tax bracket even if the tax rate remains the same.
The fact that anything a person takes out at the appropriate retirement age even the earnings can no longer be taxed is another benefit. I just wish your response to people who challenge your views were as in depth as your articles.
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Financial Samurai Reply:
April 14th, 2013 at 12:45 pm
How do you know tax rates for someone on the 15% tax bracket are going up? Not many people can make more in retirement than while they are working.
I’m happy for folks who want to contribute to a ROTH. Just contribute with your eyes wide open and pay attention to things such as $3 million IRA limitation proposals and Cyprus.
The government is too big and places almost the entire tax burden on the top 10% of earners, that’s why I’m maxing out my Roth accounts this year while I’m paying a relatively low tax rate. I’ll pay about $3,000 in taxes on the $23,000 that I’m allowed to put in(17.5k in Roth 401k / 5.5k in Roth IRA). If it grows at the historical rate of return of the S&P 500 (9.77%) this sum of money will grow to about a $1 million in 40 years. If it were in a traditional 401k/IRA I would pay about $350,000 in taxes when I took it out (probably much more because I would take these distributions over a period of time while the account continued to accumulate capital gains and it’s likely that tax rates will be higher in the future). So my options are:
A.) Pay $3,000 in taxes now <– correct answer
B.) Pay $350,000+ in taxes in the future
C.) Don't pay taxes and go to jail
It's possible that marginal tax rates could be 70% or higher by the time I'm old, and I think there's a very good chance that my effective tax rate will be 50%+, so the benefit of the Roth account could be very substantial in protecting me against future social engineering and redistribution of resources by the government. I'd rather lock in the 15% tax on this money now. There's no way I'd have to pay less than 15% on these distributions; if that were the case I wouldn't have to worry about much anyway because I'd be living in some sort of utopia!
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I have a couple questions, Im married and 30yrs old and the total income is about 95k. Im assuming from what I have read the first thing me and my wife need to do is max out our 401k at 17.5 each. Then is a IRA even worth it? 5000 a yr for both of us, assuming it is. What type of IRA would be most benefitial. I would rather not get screwed by the government when it come tax time in the end also. After I do a roth what type of investments should I choose? Sorry if my questions seem odd Im new to the roth idea
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Financial Samurai Reply:
March 12th, 2013 at 7:46 am
Correct. I’d max out $35,000 in 401k combined first, then $10,000 combined in normal IRAs if you can afford to do so.
Id go with a 70/30 mix of equities/bonds. Take a look at this net worth allocation post for more details. http://www.financialsamurai.com/2013/02/11/recommended-net-worth-allocation-mix-by-age-and-work-experience/
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I did the math when Roth IRA’s first came out and ultimately came to the conclusion that the answer is most likely this simple. Do you think you will make more annually in retirement than you do when you are working? I think for the vast majority the answer is no. Brokers love Roth’s because most of the time they are trying to get you to move money from an IRA account you already have to a Roth, hence they get fees. The government loves it because they want all they can get as soon as they can get it. For most people Roth’s are a scam. Think about this. For a Roth all taxes are on income you have worked for, for a traditional IRA taxes are on the appreciation on your saving , the money you didn’t work for and you get to pay it later at most likely a lower rate. Why do investment guru’s have trouble understanding this concept?
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Financial Samurai Reply:
March 26th, 2013 at 1:37 pm
Thanks Chris.
I couldn’t agree more. Why do people think they will make more in retirement than during the majority of their working years, I have no idea.
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Maybe cause it’s not always so simple Chris.
a true investment guru should make more in retirement than they do in their 20′s and 30′s. I am currently in the 15% tax bracket because of the loopholes in taxes in this country while I made 110k last year. I expect to be in a higher tax bracket when I am in my 40′s and letting my money work for me instead of being employed for my money. My dividends alone should be about 100k when i retire at 45 or so.
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Financial Samurai Reply:
March 28th, 2013 at 6:21 am
Having a $3 million plus dividend portfolio is great. How did you save so much? What were things like during the downturn?
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Early Retirement Reply:
March 28th, 2013 at 6:51 am
I said projected:) my REIT funds alone netted me over 10k in dividends last year. The argument is my future pension which is about 70% of my income + dividends + SS = higher tax bracket when I’m retired then the one I am currently in while working. While I do agree most people will never make more while retired I certainty plan to. I still don’t contribute to a ROTH I.R.A. though because they just don’t seem attractive to me. I invest more money monthly usually than the limit for the whole year on a Roth. Doesn’t seem like a good program to serious investor me but maybe i’m just missing something. My 2 cents.
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This article is terrible advice and stems from a paranoia in government. While I am no fan of big government and agree with the sentiment that “they’ll take all you have if you let them”, that is NOT a suitable financial argument for not using a ROTH IRA. The tax free advantages on dividends and capital gains in a ROTH IRA, especially by those who have expertise in investing in individual common stocks is great, and I fear people are being terribly mislead from this particular blog posting.
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Financial Samurai Reply:
April 10th, 2013 at 12:49 pm
Share with us your financial position, experience and age so why have perspective of where you are coming from.
If you think you can make more in retirement than while working, then good luck to you. If you think Obama’s $3 million IRA limit and Cyprus’ 30% taxing of savers with over 100k Euro won’t ever happen, then great.
If you are young fella who makes an average wage and plans to make more, a ROTH is probably OK. If not, max out the 401k and IRA first.
I don’t mind you paying more taxes to feed the government upfront. I just don’t want to and have a very chunky financial but to protect.
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But is there any advantage to a traditional IRA if you are over the deduction limit? I file jointly, and our adjusted gross income was $118,000, so we’d not be eligible to deduct contributions to a traditional IRA. So wouldn’t a ROTH be better (for us) since at least we’d be saving on taxes on withdrawals in the future? (Assuming the government doesn’t change the rules. But if they do change and ROTH withdrawals are taxed, then wouldn’t both types essentially be the same in my case?)
I’m far from samurai level and am a little oversaturated with IRA research right now, so forgive me if the answer to this is obvious and I’m just missing it.
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Financial Samurai Reply:
April 12th, 2013 at 5:38 pm
Hi Annie,
Sure, if you’ve maxed out your 401k and would like to contribute to a ROTH to have earnings grow tax free, go for it. It’s better than nothing and will also add up over the long run.
Best,
Sam
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Telling people not to fund a Roth because they have to pay taxes upfront is terrible advice, especially for younger people. If you contribute $5K/yr for 40 years, you are missing out on tax savings of $30k – $70K (15 – 35% bracket) on those contributions. If you only average 8% growth during that time (and btw, the S&P 500 has averaged ~12% returns since inception), you would have approximately $1.3M tax free at the time of retirement, which saves you $195k – $455k. You don’t have to “make more in retirement than you do working” for a Roth to benefit you. The blogger has forgotten the beauty of compound interest.
However I do agree that funding any type of retirement is better than not funding any retirement at all, so whatever you do, don’t do nothing!
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Financial Samurai Reply:
April 13th, 2013 at 8:18 am
Don’t read this post in a vacuum. I recommend maxing out the 401k first for $17,500, then max out the IRA for $5,000 and then max out the ROTH. But don’t people dare contribute to a ROTH before maxing out the other two first. Not sure why you think compound interest and returns don’t apply to $22,500 worth of pre-tax savings first, but it does to a ROTH?
I managed to accumulate over $400,000 in my 401k ALONE by the time I was 34. And my 401k is a small portion of my net worth. Please share your story and how you’ve done?
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AP Reply:
April 13th, 2013 at 11:57 am
If you max out a traditional IRA, you cannot contribute to a Roth IRA. $5K (in 2012) is the max you can contribute to any mix of IRAs total. I do know that compound interest and returns apply to pre-tax contributions, but you will pay ordinary income tax rates on those gains, which if you are starting young will exceed contributions by far. It’s wonderful that you’ve done well for yourself, but doing well for yourself does not automatically make you correct when making a blanket statement about not funding a Roth in favor of a pre-tax IRA.
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Financial Samurai Reply:
April 13th, 2013 at 1:44 pm
Do you think you will make more in retirement than you will make by working? If so, please demonstrate some simple math on returns and how much you think you will amass.
Also, please give me an idea of how old you are and how much you’ve accumulated in this time so I know whether I’m talking to someone with experience or not.
Thanks
JB Reply:
May 7th, 2013 at 8:26 pm
I have the same question as AP and I do not understand your reply. Compunding would equally apply to a traditional or ROTH IRA but when it is time for the money to come out the traditional IRA it will be taxed at ordinary income rates and the ROTH monies would all be tax free. So if there are a lot of years to take advantage of time and growth through compounding the extra tax up front on the contribution amount of a ROTH would be less than having the entire amount of a Tradidional IRA taxed (albeit at a lower tax rate). Also if one already has a max contribution to a 401K and can only make an after tax contribution to an IRA then it is better to have a ROTH IRA (likely have to contribute to a traditional then immediately convert since there is no income restriction on conversions). I am 45 and and have 900K in 401K/ROTH IRA. I converted a traditional IRA in 2007-2009 (paid the tax with money outside the IRA) and since then that account has grown from 120K to 200K. I shouldn’t need to touch that account for another 20 years if ever.
How does the minimum required distribution factor into this? Say you reach age 70 1/2 and are required to take RMD? How about passing down to children as inheritance? I used to think mathematically it made no difference, should tax rates remain the same, then I realized that I currently have children, which reduce my tax because of exemptions I can claim. Won’t be the case in retirement. That + RMD made me think Roth is the better option. Am I missing something?
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I want to add to your article!!!
This is great. I wish I had read it when I had just started out of college and into my first job.
Instead I did open up a ROTH IRA. But I put a little money in there just the first year $5000. Fast forward, like 6 years later. With all the fees and taxing up front, the money I put in has still yet to recover!!! (It’s still only like worth $4,500).
How sad.
This is not being inflation even. Most people I know are also in the same boat.
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Anyways, the point I wanted to make was that I agree. If you save a lot of money in your 401K to be taxed later, it is better. The simple reason is that EVEN if you are taxed at a higher rate in your 401k because you make more, YOU ARE MAKING MORE MONEY. It’s not like you are going to be starving for cash. You can probably AFFORD the tax later if you are MAKING more money then.
Right now, you need more money because you are making less.
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