Disadvantages Of The ROTH IRA: Not All Is What It Seems

Passed Out Drunk Vomit Oozing From Mouth For 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 IRAs. The government was so successful in getting people to pay huge sums of taxes on their IRAs during the financial crisis that I just shook my head in disbelief.

As a personal finance blogger who wants to help you achieve financial freedom sooner, rather than later, it’s my duty to write this post to help you see the error in contributing or converting to a ROTH IRA if you have not maxed out your 401(k).

Of course 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.

Please read the reasons why a ROTH IRA is not a good idea for the large majority of you. I really hope this article will wake you up to the tremendous government brainwashing that is being conducted to get you to part more with your hard earned money. 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 ~2.9% (as of 1/18/2014), you need $4.3 million dollars to generate $122,000 a year in income!

2014 INCOME TAX BRACKET – GIVE ME MORE OF YOUR MONEY!

2014 Income Tax Bracket

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!

Recommendation For Increasing Your Net Worth

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One of their best tools is the 401K Fee Analyzer which has helped me save over $1,700 in annual portfolio fees I had no idea I was paying. You just click on the Investment Tab and run your portfolio through their fee analyzer with one click of the button. Their Investment Checkup tool is also great because it graphically shows whether your investment portfolios are property allocated based on your risk profile. There is no better free online tool that has helped me stay on top of my finances more than Personal Capital. It’s important to aggregate all your accounts to get an entire overview of your net worth to make proper changes. It only takes a minute to sign up.

Updated as of 2014

Regards,

Sam

Sam started Financial Samurai in 2009 during the depths of the financial crisis as a way to make sense of chaos. After 13 years working on Wall Street, Sam decided to retire in 2012 to utilize everything he learned in business school to focus on online entrepreneurship.

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Comments

  1. Sam says

    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!

  2. shawn says

    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

  3. Chris says

    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?

      • Awakeinwa says

        I have no idea why you’re conflating making more in terms of salary with investment returns that will certainly stand at double if not triple digits over a person’s decades long retirement journey. If that is the case, Roth protects those double plus digits from any future taxation with the cost of paying taxes on the original much cheaper principal you put in.

        Not using a Roth is just bad, horrendous math at work.

        • Hank says

          How can you be sure that whether Fed Gov’t can’t tax the Roth IRA. After 10 and 20 years they may change the rules that Roth IRA will & need to pay tax again therefore why tax now when we are not sure what Washington will do 10 or 20 years from now. Do not pay taxes now but deferred to gain your balance.

  4. says

    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.

      • says

        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.

  5. Benedict Gomez says

    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.

    • says

      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.

  6. Annie says

    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.

    • says

      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

  7. AP says

    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!

    • says

      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?

      • AP says

        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.

        • says

          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 says

          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.

  8. Ben says

    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?

  9. Grace says

    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.

    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.

  10. Lucas says

    I agree that ROTH is definitly oversold and is not the best for most people!! You sort of touched on it, but i think you could expand your calculations to cover the fact that if you put into a 401k or regular IRA you save money at your marginal rate, but only pay out taxes at your average tax rate when you withdraw (assuming most of your income is from tax defered retirement accounts). This is a huge factor for my calculations becuase while my marginal rate is 25% (federal) right now, I expect my average rate to be <10% as I plan on keeping my income needs very small. Even if you keep income needs the same i only pay an average federal rate of 14% right now which is much less then my margin. So 401k or regular IRA makes a lot of sence in that case.

    You should probably max your HSA as well in advance of your ROTH or even possibly 401k/IRA as it is one of the only ways to get tax defered and tax free money!

    Couple reasons/situations why I think ROTH is still a good idea:
    1) if you don't quality for regular IRA based on income
    2) if your marginal tax rate is very low and you are maxing employer match in 401k I think it makes sense. Backburner plan I have is that if i retire early with low income needs (and hense low margin rate), then i would consider setting up SEP withdraws from my IRAs to move into a ROTH little by little rather than paying a huge conversion tax bill based on my inflated margin rate.
    3) For your kids! If you have a business and can employ your kids they have earned income and can contribute to an IRA (or you can transfer money to them via gifts that they can contribute). And since their marginal rate would be so low it would make sence to do a ROTH
    4) If you have a lot of money to save you are technically saving more in a ROTH then an IRA becuase 5k tax defered is less then 5k tax free. So if you are maxing 401k and HSA and could easily max an IRA with a lot of money left over then you might consider ROTH. Glad I have that problem :-)
    5) College Fund for kids – I personally like the ROTH setup as better than any of the 529 plans for saving for college for my kids as the money is more flexible on use (rather than just education). It helps if you have family members who are gifting you money towards your kids as well.
    6) Tax diversification is a good thing.
    7) Estate planning – ROTH is better for giving as an inheritance
    8) No RMD – you don't have to take money out of a ROTH no matter how old you are, but the gov will force you to from an IRA as they want their taxes ;-)

  11. ap999 says

    Sam, you have great points, I never saw this and most people don’t. When you think about it, most people are sheep. When we hear something on TV, read it online on top online websites, top books, we take it for what it is without doing our own homework.

    After reading your blog on this topic, I did not believe how it made sense until I did my own research outside of this blog.

    Also I see why people are so brainwashed on why the Roth is better if you qualify for it due to income restrictions. If you go google Roth IRA vs Traditional, you will come up on 1000s of articles on why the roth is the way to go.

    I have to say, even though I may not totally agree with some of your topics here. At least it has me thinking and forcing me to do my own research outside of here, to make a better informed decision.

  12. says

    Hello, I need some clarification. Sam, in your comments you said you can max out your 401K, then max out IRA, then max out ROTH IRA. My understanding is if you have a 401K, you cannot fund a Traditional IRA. Please explain. Thanks

    • says

      If you contribute to your 401(k) account, you may still contribute to a Roth IRA and/or a Traditional IRA; however, your participation in the 401(k) plan may affect your ability to take a tax deduction for any Traditional IRA contributions. It will not affect the amount you are able to contribute. (To learn more, see Are You an Active Participant? and Traditional IRA Deductibility Limits.)

      Your 401(k) contribution has no effect on your Roth IRA contributions. You only need to ensure you meet the eligibility requirements for funding a Roth IRA.

      Your eligibility to claim a deduction for your Traditional IRA contribution on your federal tax return depends on whether you are an active participant of an employer-sponsored plan in the year to which your deduction applies. If neither you nor your spouse is an active participant, you may deduct your full contribution for the year, to which a limit applies. If, however, you are an active participant, your tax-filing status and modified adjusted gross income (MAGI) determine your eligibility to deduct your IRA contribution. Here we take a look at how to determine your active-participant status, which can be tricky as the rules vary for each type of employer-sponsored retirement plan.

      From Investopedia

  13. johnny boi says

    Good suggestion on maxing the 401k, however one thing I don’t see noted is that once your $ is in the ROTH it grows tax free and after 59.5 the distributions are tax free. That seems like a heck of a good thing. Can you comment on this?

    Love the site btw.

  14. Jacqueline King says

    I have been on disability retirement for about 1 1/2 years. I converted Traditional IRA into Roth IRA 1 yr ago. I am needing to withdraw most of my money from my $2330.00 Roth IRA because of a recent financial emergency. It is my understanding that I can withdraw under disability. Doing so will decrease early withdrawal penalty significantly. Do you know how much penalty I would pay if I receive distribution under disability?

  15. Philip Baron says

    There is one flaw in Sam’s in Tax planning comments on the ROTH. If you are successful in your investment strategy (and many of you will be) and the government keeps spending like crazy (which it no doubt will) then it is quite possible that your tax bracket or tax rate will go UP when you reach age 59 1/2. That means you’re better off paying the tax now and never having to worry about paying it again. People are living longer and will live even longer yet. Thus you may still be working at age 59 1/2, in a high tax bracket, and yet desire to take distributions from your ROTH Ira. Those distributions, no matter what your tax bracket, will be entirely tax free. That’s a benefit that’s hard to beat!

  16. says

    Hi, I’m curious on your take for someone like me who is in a lower paying profession that is not guaranteed to be significantly high paying in the future (non-profit). Perhaps in 10 years, I may be lucky to be making 6 figures, but inflation is a dirty dog. Would you still recommend to not get a ROTH IRA? I don’t have much investment for my age (I’m 28) due to my lack of financial education until recently. I have a traditional IRA now but I was looking at starting a Roth.

  17. John says

    What are your thoughts on a Roth when you intend to use the money to fund the down payment on a first time house? Can’t you withdraw the gains without paying taxes for that purpose?

  18. Awakeinwa says

    I strongly suggest people confused about Roth to reconsider the advice of this post – it is horrendously misinformed and just breaks down when you do the math.

    Roth prevents future taxation on all future compound returns you will gain by retirement with the expectation that you use after tax money now to invest in the original principal.

    20% tax paid on $10,000 principal now that yields $100,000 of compound returns by retirement is far cheaper than getting tax free dollars now to invest only to pay 20% on $100,000 10 years from now.

    It’s patently absurd to max out your 401k at expense of one’s Roth.

  19. Sylvia says

    Financial Sumarai,

    I’m a newbie as it relates to the financial planning research arena but I have 2 questions.

    1) How can you both accumulate a lot of money in a 401k plan and state that you will be a lower tax bracket when you retire in light of RMDs. First, in a 401k plan, you are not allowed to take out any money (with limited exceptions) without a penalty until you are 59.5. This is not true with Roths that allow you to take out your contributions (not earnings) without penalties (assuming you’ve had it for 5 years). Second, you are required to deplete the 401k by virtue of the RMDs starting at age 70.5. If you have the amount in your 401k plan that you recommend, it will be impossible not to be in a high(er) tax bracket when you have to take out AT LEAST 5% of the value of the account per year once you hit 70. This coupled with SS will necessarily ensure that you are less likely to significantly reduce your tax bracket – and that’s assuming that the tax rates themselves don’t increase.

    2) Have you taken into account all of the exemptions from income of distributions from the Roth? Distributions from Roths are not counted as “income” for purposes of calculating eligiblity in a significant number of state and federal programs including the actual tax paid on SS benefits, eligibility for senior property tax exemptions, etc.

    Using Roths eliminates the guessing game of future tax rates and provides more flexibility in terms of distributions. It also allows you to pass money to beneficiaries tax free. I don’t think that a person who is willing to gamble that the difference in what he/she receives each month by paying taxes upfront will pale in comparison to the tax savings he/she receives by eliminating all of the future Roth distributions from income, not being required to take RMDs, not being taxed on the distributions themselves and the overall peace of mind of knowing exactly how much money is in the account for plainning purposes should be so easily dismissed.

    • says

      There’s no problem using a ROTH to diversify our tax liability. However, I think it is suboptimal to contribute to a ROTH before maxing out a 401(k). Please share with us your investing experience if possible so I can understand where you are coming from e.g. 25 year veteran. Thx

      • Sylvia says

        I am in my early 30s, single, and in the 28% marginal tax bracket. As a single person, I figure that I will be in at least the 25% tax bracket for any income exceeding 36k. I do not plan on taking SS until I am 70. The SS benefits alone will be approximately $25,000 per year. Let’s assume I have the option of putting money into either a Roth 401k or a standard 401k (for purposes of the argument I plan to do a rollover from my Roth 401k to my Roth IRA upon retirment). Let’s also assume that over the course of working I am able to amass $1M in either a Roth 401k or a standard 401k.

        The amount of the RMD I would be required to take from the 401k plan is calculated by dividing the balance of the account by my life expectancy. The single life expectancy chart can be found here (http://www.irs.gov/pub/irs-pdf/p590.pdf#page=94) At the age of 70, my life expectancy would be 17 years. $1M/17 years would be approximately $59k. That means that just between my SS and the RMDs, I would have approximately $84k per year as the very miminum income. Any maneuvers witht the 401k prior to the age of 55 (for certain exceptions) or 59.5 could incur penalties, and with very few exceptions, any withdrawal would be taxed at ordinary income rates.

        On the other hand, if I amassed $1M in a Roth 401k that I rolled over to my already existing Roth IRA, I would not have to take RMDs, I could take out any of the contributions at ANY time without incurring penalties (assuming I had the account for 5 years which I already have) and none of the distributions are counted as income for federal taxation purposes or for the state in which I currently live. I do not know how different states treat withdrawals from Roth accounts. Therefore, I could withdraw the same $59k tax free, and my only reportable income would be my SS benefits.

        I have nothing against 401k plans and I am a fan of saving for retirement in any vehicle a person sees fit. I just don’t see how you can declare Roths to be the inferior option if the the overall goal is to reduce the total amount of taxes paid. There are legitimate pros and cons to Roth options. But, if you are single, it would be very difficult to max out a 401k and receive SS benefits and still substantially lower your income enough to make Roth options universally “suboptimal.” I haven’t run the numbers, but I suspect it is also true for married couples with combined incomes over $160k.

        Please explain to me in numeric terms why you believe a Roth IRA and/or a Roth 401k to be subptimal. Your argument about income discrimination should not be considered because anyone regardless of income can convert a non-deductible traditional IRA to a Roth IRA without any tax consequences (if they do not have other traditional IRAs with pre-tax money).

        Like I said, I’m new to this arena and fairly late to the game, but I’m interested in learning as much as I can. Congrats on the blog and thank you for your posts.

  20. Jeff says

    I like some of the great comments here that a setting the record straight with The benefits of a Roth IRA. Tax free capital gains is THE primary benefit, which is something the Samurai seems to avoid sharing.

    Perhaps you can walk us through your “Y=A*B” equation with some real numbers to prove your point.

    On average these are great articles but when it comes to facts and numbers the Samurai’s attention to detail fades quickly (which is surprising for some who claims to be a former I-banker).

    Let the buyer, er reader, beware!

    • says

      Have you run the numbers on tax free capital gains after paying taxes on the initial contribution vs the other way? Go ahead and let me know what you come up with.

      You don’t have to justify your choice. In fact, we need people like you to pay taxes up front to help keep our shut down government open. So thanks!

  21. Susan Prince says

    I’m a newbie, and I’ve been thinking about rolling my small pension of 21K into a gold IRA. Is the a bad idea ? With economy being like it is and the dollar shrinking, I don’t have much to rely on for retirement .

  22. MK says

    I have to disagree with this advice. The Roth IRA or Roth 401k make more sense in the following cases:

    1. You are in the middle to upper tax brackets and plan to stay there after retirement due to income investment.
    2. You believe the tax rates may be the same or higher in the future due to budget deficits.
    3. You are planning to be successful in the future and amass a high net worth that generates income (rentals, dividends, etc.)
    4. You already have a big chunk in a traditional IRA or 401k and want the flexibility later to take money out tax free (diversify your withdraw options).

    People forget that traditional IRAs and 401k’s are tax “deferred” not tax free. There is no rule on what that tax rate is guaranteed to be in the future. Could it be 50%? Could it be 70%? There are historical rates that support that in the US and other countries at different time periods. I guess it depends on how confident you are in the federal and state politicians are at managing budgets.

      • M says

        Hi,
        first of all, I’ve been reading the site and I like it a lot. Very good advice and exactly the kind of things I’ve been looking for. I’m not retired. middle aged, self employed business owner, saves diligently. My business is growing. I try to save half of what I make. I got lucky in real estate, have a bunch of rentals. Estimated net worth > 2.0M. If I plan for success, I will have rental income, investment income, dividend income, interest income after retirement. If I am successful, I will have an equal or greater income in retirement.

        If the government raises tax rates to cover budget deficits, then my retirement tax rate could be higher. So, let’s say I have 500k in a 401k, why not start contributing to a roth 401k instead. I can pay a known tax rate now, or gamble and pay an unknown tax rate in the future. With a roth, when I retire, I can choose which plan to withdraw from given the current tax rates and have the flexibility from year to year depending on the tax codes.

        I’ve been reading up on Jeff Brown’s ideas. bawldguy.com/ He’s not very big on retirement plans at all, instead he thinks you should cash it out. I’m not that aggressive, and I’m not affiliated with him. But I do look for the best ideas to fit the needs.

        • says

          Hi M,

          There’s no problem in paying taxes up front to diversify a $2 million net worth. I guess it depends on how much you are making now and what is your tax bracket. $2 million may spit out $60,000 a year in retirement relative risk free, which isn’t putting you in a very high tax bracket at all.

          With a $2 million net worth, I highly suggest you sign up for Personal Capital. Personal Capital is a free online management management tool that helps you keep track of all your finances in one place. You can track your budget, monitor your net worth, and run your various portfolios through their Portfolio Fee Analyzer to help save you money. It’s an inevitability you will open up multiple financial accounts if you are serious about diversifying your net worth and achieving financial independence. In my case I’ve got 28 financial accounts which I can keep track of via Personal Capital. I’ve sat down with Bill Harris, the CEO of Personal Capital for a couple hours in their offices in Redwood City and I’m confident their product will help improve your finances for free.

          Regards,

          Sam

  23. M says

    Thanks for the reply, but that assumes I’m retiring now. I’m planning to work for 20 more years (I like what I do). So it would be the future value of $2M now compounding for 20 years at 7% and also adding 100k each year until retirement. That would be about 11.8M at retirement year 1 generating an annual income of $473,556 at a 4% withdrawl rate (if the stars align). Of course you would have to factor inflation as well which people rarely do.

    Thanks for the tip, I used to have lots of accounts and brokerage firms, but now I have just 3. I have found simpler is better. Especially if the numbers in the accounts are bigger.

  24. P says

    Long time reader, first time commenter. Had two questions that I wasn’t able to find previous posts on:

    1) For military, would Roth IRA and Roth 401K (or TSP) make sense since salary is fairly tax-advantaged in the present (e.g. typically no state income tax, no Federal income tax on a good portion of our salary due to untaxed allowances) assuming work at another non-military salaried career prior to retiring?
    2) Wouldn’t Roth 401K’s make sense in general since they effectively allow you to contribute more? For example, wouldn’t the pre-tax contribution of $17.5K for a Traditional 401K would be equivalent to a lesser post-tax contribution for a Roth 401K? So by being able to contribute the same $17.5K post-tax, it seems like you’re able to get more untaxed earnings in the end. Or my math is wrong, which could be entirely possible. Thanks!

  25. P says

    Quick question:

    For military, does Roth IRA and Roth TSP (401K) make sense since our salary is fairly tax advantaged (typically no state tax, lower Federal tax due to untaxed allowances)?

    Thanks!

  26. 401kdummny says

    good evening,

    I have no clue which one I have to do, traditional 401k or Roth IRA, i am Making 50k/yr,
    another twist to add i just got married and she is making 60k/yr ..

    where should i put my money ? i am planning to get a house next year.
    by the way i am from NY.

    thank you

  27. alter says

    I’m actually doing the opposite of what the article suggests, and increasing my Roth and reducing traditional pre-tax . I have a traditional pension and between the pension, 401k with match, and SS, and possible future tax increases, I’m pretty confident my retirement tax rate will be higher, all other things being equal, and even if its not the piece of mind you get knowing your balance is compounding tax-free and there will be no RMDs is worth a lot. For the last few years I’ve maxed out my 401k pre-tax contributions and maxed out my Roth IRA and HSA. I’m very active with the Roth IRA and do things like selling covered call options and have it loaded with relatively high paying dividend stocks and etfs to generate income. Next year for the first time I’ll be maxing out the Roth 401k+Roth IRA. For people who want to max their retirement savings, I believe this is a great method. One little talked about aspect of maxing out a Roth 401k account is that, god forbid something bad happens and you lose your job, you can roll it over into your existing Roth IRA, which will give you even more income, flexibility and investment options and that will never be taxed. I like this site but a lot of the articles seem to suggest that the retirement accounts will earn little to no interest every year, but I think if you’re willing to spend a little time and actively manage your investment accounts for income and growth, you can get by with far less than average account balances and just live off the income instead of the principal.

  28. non invester says

    Hi, I am currently on SSDI and private long term disability (43 yrs old) and I will be receiving a settlement in the next few months. As my home is paid for outright I am thinking the majority of these funds need to be invested to assist in my income when I am older and the LTD runs out leaving me one day depending on the SSDI which is unlivable. I was considering a ROTH IRA as the stock market scares the **** out of me. I have NO taxable income as my LTD premiums were paid after taxes.
    My questions are – can i open a ROTH IRA with no taxable income? And, can I make only one contribution and leave it there as opposed to monthly or yearly?
    There is no way I can continue regular contributions on my limited income. I have considered leaving it in savings but I’m afraid that they interest will make my SSDI partially taxable, and there is always the chance I will see something I ‘need’ and spend it leaving me even more destitute when I am older. My plan is to take care of my long term needs i.e. home repairs then put the rest away and forget its there.
    Thank you in advance

  29. Emilie says

    I am very new to investing, still trying to research and learn so forgive me if my question seems ignorant, I appreciate any information you have (love your site by the way and have spent half the week reading articles and comments). My husband works (I stay home with our 3 young boys) and grosses around $140,000 with bonuses. We live in central IL with a very modest cost of living. Our net worth is at $219,500, a long way from where I want it to be, but it’s a work in progress. My question is, our financial adviser advised against contributing more than what my husband’s company will match in his 401K because they only match $900/year and the investment options are very basic – Bond (Fixed Income) or Large Cap (equities). I’m still trying to understand all this so again, forgive me.
    We have been maxing out roth IRAs for the last 5 years. I know one of the reasons we chose roth over traditional is the ability to withdraw what we put in towards college for our kids, should we need to (we are not planning to, but it provides flexibility). This was a compromise for us, to start investing by allowing us to put it towards retirement with some more options down the road. So, that being said, do you think we should stop maxing out our Roth’s ($10,000/year) and put all of it in his 401k? I hate to do that because as a stay at home parent, not contributing even to social security, investing in my own retirement feels like a better choice then just putting it all in his. I’m really curious on your thoughts here?

  30. Dan says

    I may be completely wrong, but my impression in reading this article is that it is missing a big part of the picture here…

    Roth IRAs have no taxes, ever again, on all capital and dividend gains. That is to say that a single $5,500 investment, grows at let’s conservatively say 5% (no inflation involved). That investment after 40 years would be 40kish and kicking off almost $2,000 a year in income. All tax free…

    It is my understanding, you would be paying your income tax rate on those distributions, if it were a Traditional IRA or 401k.

    Won’t lie I would rather pay 20% on my 5,500 now. Than 25%+ on my 40k, in 40 years.

    That said, I am diversified between Roth and Traditional/401k holdings, because I very much believe we have absolutely no idea what the tax situation will be like in 20, 30 or 40 years.

    • says

      I hope to goodness you don’t have to ever pay taxes again after you pay so much tax up front! But the government can change the rule on you and tax you upon exit too. As soon as you pay taxes, you lose.

      But if you believe you’ll pay higher taxes in the future, definitely contribute the max and diversify. I would just much rather you max out the 401(k) or traditional IRA first.

      • tom says

        Sam,

        I think this is what’s missing from your article. As with everything finance, it all depends on your situation.

        You are assuming people will stay in the same income bracket their whole lives and/or go lower in retirement. An upwardly mobile person making $100K today at a young age (in the 25% bracket) will most likely be a higher tax bracket when they retire assuming they max out their retirement savings vehicles. That person would most likely be in a higher bracket when they retire.

        You say that the government can just change the laws on a whim, but that law sticking isn’t certain, and frankly, it’s highly unlikely they’d ever pass a law like that. The political blow back would be huge, not to mention that the law would be taken through the courts.

        My point is, it all depends. Roth IRAs are a great investment tool if you are increasing your income.

        • says

          It does all depend on your situation, but people need to do the math.

          Do you think you will make MORE in retirement than while you are working? If so, do a ROTH. If not, which is 95%+ of the case then I recommend against giving up and letting the government take your money.

          • Dan says

            You really believe that 95% of kids 22-28ish with AGIs anywhere from $40-70k, are going to make less money in retirement? I dunno, that doesn’t sound right to me.

            I’d start to agree with you more as the incomes get over that threshold and head toward the 6 figures range. But I have a hard time believe that young professional will make more fresh out of school than they will with 40 years of retirement savings.

            • says

              Do the math. If you are retired you are no longer working. To create $70,000 a year in retirement at a 3% return requires having $2.33 million. Now look at what the average American has saved for retirement. Now calculate how to get to $2.33 million earning $70,000 a year.

              But, I’m very happy that so many ROTH believers think they will be sitting pretty in retirement. We’ll have a much stronger economy as a result.

  31. Nick says

    What are your thoughts on investing in a Roth 401k for people starting into their jobs? I am currently in the 25% bracket and traditional 401k vs roth 401k doesnt change my tax bracket. Math suggests its worthwhile to invest in the roth option (for my contribution beyond the company match) so that it grows tax free. Your opinion is muc appreciated.

  32. S says

    I just found your site this week and I really enjoy it. I may be missing something, but what are your thoughts of using the back-door Roth IRA conversion method for high-earners who are already maxing out their 401k. Because of my AGI, any contributions to an IRA would be with post-tax dollars. The back-door conversion method at least allows me to convert some of those post-tax dollars into a Roth IRA that is (as of now) forever tax-free. Obviously, things could change, but this would simply be a method of tax diversification. The benefit of putting money in an IRA even if not deductible is: (1) grows tax-deferred (or completely tax free if Roth), (2) creditor protected exempt asset, (3) systematic forced savings program. But since I get no deductibility now, might as well convert to a Roth and hopefully escape any further taxation. Do you agree? If I’m missing something, please let me know.

  33. Mark says

    To be blunt – you are completely wrong. If you want to see the mathematical representation of a ROTH vs a before tax retirement computation I would be happy to share with you personally. This can easily be represented over time and the after-tax contribution wins 100% of the time assuming a certain duration. Your formula is far to limited and does not take into account earnings growth or the value of compounding. Further, you can not monetize something as RMD’s. Many employers now offer an option to distinguish a 401(K) contribution as a ROTH 401(K) – whereas after-tax money is contributed versus before-tax money to the plan. Anyone who argues this is not preferable, does not fully understand the mathematical representation of each before-tax contribution vs after-tax contribution to a retirement plan. Hopefully you were just talking about the idea of investing in a 401(k) versus an IRA plan but you did not leave it at that. You are completely wrong in numerous statements. I enjoy reading your thoughts and they are usually very accurate, very frusturating to read something though that is so completely far from the truth.

    • says

      Id love to have you back up your assertion with the mathematical examples you talk about instead of just saying I’m wrong with no back up.

      Please do so and shoot me an email. I’m happy to publish on article here why my position of maxing out a 401k and not giving in to the government by paying taxes up front is wrong.

      My biggest curiosity is how you will calculate earning more in retirement than while you were working. Please also be sure to state your age, net worth, tax rate, and current retirement contribution balance so we get some background of where you are coming from.

      Thanks!

      • S says

        I just don’t see how anyone can state with certainty what tax rates they will be in the future. If one’s tax bracket is always going to be the same, then it makes no difference. But there is no one who can assure that will always be the case.

        Thus, in general, I would prefer to not pay taxes now, which is more of a certainty. Unless I was in a very low tax bracket now.

        Ideally, you would max out your 401(k) and then contribute to a Roth to get some tax diversification. Both accounts have creditor protection and both are forced savings that have disincentives to touching them until later in life (which is a good thing).

    • Ravi says

      Contribution to a 401K vs Roth essentially boils down to what your tax rate is today and what you think you will pay when you withdraw those funds. If your tax rate were to remain the exact same now and in retirement, then mathematically it would make no difference. Compounding actually doesn’t matter either way. 401K will compound with a larger balance, but you’ll pay the tax when you withdraw. Roth will start off lower, but will compound tax free. In both accounts, you do not pay taxes between the contribution date and withdrawal date (if you did… THEN there would be a difference between the two).

      I like what others have said. The truly best strategy is to save in a 401K & Roth (the real benefit of either account is deferral of taxes between contribution and withdrawal). Outside of that, it’s a wash. Assuming you can save $23K+/yr, max out both accounts and you’ll be doing great!

      The only disagreement I have with Sam is for those of us who cannot max out both accounts and are expecting to cross the income threshold for Roth at some point in the future. In that case, it may be beneficial to have Roth in early years (even if you cannot max out the 401K) and then switch to 401K when you cross the income limits.

      Regardless, passive income is the best! Even if it is taxable…

      Here’s to all of us becoming Donald Trump (minus the media coverage).

  34. Eric G says

    If the question is which of Roth or IRA will lead to a larger nestegg in retirement, then all the arguments about government efficiency are simply besides the point.

    We do know that a person who expects to be in a higher marginal tax bracket in retirement than they are now has a good argument to choose Roth. An interesting situation arises however when we assume the same income now and in retirement. For moderate savers (and by that I mean retirement income of less than about $5,000 a month), the IRA benefits from years of applying a standard reduction to annual taxes.

    The Roth has a couple distinct advantages. For one, it allows a larger contribution than a 401k. This is a bit non-intuitive but it happens because the (say, $17,500) contribution limit of a young person in 2013 is the same amount for Roth or 401k, but the Roth is figured on after-tax dollars. So e.g. if the applicable tax bracket is 0.25, the maximum Roth contribution is effectively 17,500/0.75 of pre-tax dollars. The other advantages have to do with better flexibility for loans before retirement and rules for distribution in retirement.

    My opinion ? The choice has to be made in the wider context of retirement planning. Examples of pertinent questions include anticipated income during retirement years and money left for the next generation.

    Second opinion ? Roth vs IRA/401k is more a religious argument than real for most people. Do both if in doubt.

  35. Eric G says

    RE: the math or Roth Vs 401k
    If the tax haircut is equal — same tax rate, then the returns are equal

    A = A(o) * (1+i)^T * tr

    where tr is tax rate,
    A is amount
    A(o) is initial amount
    T is years of compounding

    If tr is the same, it does not matter if it is the beginning or end of the math expression :)

  36. Eric G says

    Sorry, I should have added to comment above that the equation is for one year of savings. But subsequent years follow the same logic.

  37. JP says

    1. Put $5k in a traditional IRA….it grows to $50k. You cash out at age 60. Your tax bill is 20% * (50k-5k) = $9k in taxes!

    2. Put $5k in a Roth IRA….you are taxed now. your tax bill is 20% *5k = $1k in taxes….it grows to $50k. You cash out at age 60….you pay no taxes when cashing out…earnings grow tax free.

    The Roth IRA costs you $1k in taxes. The traditional IRA costs you $9k in taxes. Clearly the Roth IRA is superior to the traditional IRA.

  38. JP says

    Ignore my previous post. It is deeply flawed.

    1. Put $5k in a Traditional IRA. Contribute $5k every year. Growth rate 10% a year. 30 years later it is worth $909,717. Let’s say you withdraw it now. Your tax bill (20% tax) is $181,943. After tax total is $727,773

    2. Put $5k in Roth IRA. You are taxed now (20%). You are left with $4k after tax. Contribute $5k every year. After tax you are only contributing $4k a year. Growth rate 10% a year. 30 years later it is worth $727,773

    Conclusion: Roth and Traditional are the same if your tax bracket stays the same now and in retirement. Roth is only better if you will be in a higher tax bracket when you retire. Or if you expect tax rates to increase in the future.

  39. William S says

    Just wanted to say that the first time I read this post months ago. I thought there must have been some problem with your math. However, today I stumbled upon an article talking about IRA’s and realized that you were correct.

    There are 2 ways that a ROTH IRA is actually better though.

    1)

    Roth IRA:
    Lets say you make a contribution of 5k to a ROTH this year (and are in the 28% income tax bracket). You pay $1.4k in taxes but now have 5k in a ROTH IRA. Let’s say over 30 years, the 5k is now worth 50k (8% compounded annually).

    At the end of it you have 50k and paid 1.4k in taxes.

    Traditional IRA:
    Lets say you make a contribution of 5k to a Traditional IRA this year (and are in the 28% income tax bracket). You pay no taxes and now have 5k in the IRA (and have 1.4k extra cash to invest in a non-tax advantaged account). Let’s say over 30 years, the 5k is now worth 50k. The 1.4k is now worth 9k averaging (6.4% compounded annually after tax of 20% [mix of tax on long term and short term capital gains]). You pay taxes on the 50k at only 20% tax so 10k on taxes.

    At the end, you have 49k and paid (10k + 5k) in taxes. (The 5k is a mix of loss of profit and tax loss).

    You do give more money to the government with the Traditional IRA. The difference here comes from the fact that what you initially pay in taxes is not part of your contribution to the ROTH. This is effectively allowing you to put more money in at once.

    2)

    If you invest the money in your ROTH in a business you found with a friend. IRAs don’t allow you to hold more than a 50% interest in a business. However, if you found a company with your ROTH money, it effectively allows earnings that you are making personally to enter your ROTH untaxed.

    Hopefully this made sense.

    • says

      I’m glad you realize my math isn’t problematic.

      At any rate, a ROTH IRA is fine if you’ve maxed out your 401k and want to diversify your tax liability, especially if you aren’t making much at an earlier stage in your career. But I suggest always maxing out the 401k first.

  40. Steve says

    $66k is (was) the income limit *IF* you have a retirement plan at work. If you don’t then it’s not a limit.

    I agree with you that the drum beat of ROTH ROTH ROTH is way overblown. But, in many (not all) ways it’s better than after-tax investing.

  41. joe says

    I make 500k a yr, and maxed out my roth 401k. I can only make a trad IRA, NON-DEDUCTIBLE..which sucks, since that means i paid income tax upfront and will pay income tax on the way out again!

    question is, should I convert my TRAD IRA into a ROTH IRA…so at least I wont pay income taxes on the way out?

    BUT BUT….the gamble is this. When I retire in 20 yrs and expect 100k/yr income for retirement….will 500k income tax rate today be lower than 100k/yr tax rate 20 yrs from now?

    …would suck if 100k/yr in 2034 has a tax rate of 50%….

    • says

      Don’t do any conversions unless you have a year where you make no income, and then calculate the amount of conversion to pay minimum taxes. Basically your conversion amount gets added to your income calculation for the year.

  42. N says

    I’m 21 and graduating college this year. I have manageable student debt to pay off, and no credit card debt. But I’m not looking at a six figure salary for a very long time. I intend to allocate some of my earnings to an emergency fund, long-term savings (retirement), and the rest to other expenses. This is all very new to me, but the Roth IRA I’m looking at requires a minimum payment of ~$1,000. I know I can stand to invest this amount my first year out of college even with my monthly student loan payments, plus small amounts for the foreseeable future. Is it worth investing with comparatively limited funds annually from the start in my 20s? Or do I simply need to earn/save more money before getting started? Is it better to just pay off my student debts first (<$25,000 all "low-interest" federal loans at 3-4%)?

  43. says

    I use ROTH because I’m above the limit to defer under traditional, and below the limit to contribute to ROTH. Otherwise, you’re right–traditional is always better as long as you get the deferral.

  44. Random Reader says

    OP, I applaud your dedication to blogging and sharing your insight but a few things to note:

    While I do believe that the Roth vs Traditional discussion depends on the situation of the person you did forget several important things for Roth.

    1.) No required distributions – assuming you can amass a decent nest egg you are never required to take distributions unlike a 401(k) or a Traditional IRA. This means if you can continue to grow your nest egg, better than investing outside the Roth construct, ceteris paribus. This also goes for estate planning. If you were to die, the money could stay in a Roth for your designated beneficiary.

    2.) Choice of investments. In a 401(k) you are limited to your company custodian’s investment choices. Don’t see a fund you like, too bad. With an IRA you can choose any fund. Note: This argues for Traditional/Roth IRA over 401(k)

    3.) Maximum contribution. You can contribute the same after tax dollars to a Roth as pretax dollars to a Traditional, thus you can contribute more to your nest egg compared to traditional if you can max out, all things being equal.

    —————————————————————-

    Also the below are opinions (not facts) and I don’t think they should impact the decision on whether you should put money in a Roth.

    (1) The government is inefficient. – Sure, but who is to say that they will not be inefficient in the future? At least we have a chance to realize what we can change now; throughout our lifetime than giving tax dollars to the gov’t when we are say.. 70. If we wait we may never see some of those policies or return on our social money. I disregard this because it really doesn’t have anything to do with choosing Roth vs. Traditional.

    (2) The government is smarter than you. We have a say in how our money is used. Some of this Roth education is simply due to the fact that many people don’t know how to save, especially at the lower income levels. Wouldn’t you want to have the option to choose what you think is best for your future? Make your own educated decision, based on your research. Again moot point. Just because someone advertises something doesn’t mean it is always propaganda.

    (3) You allow asymmetric reward or punishment between equals. – There are ways of funding a backdoor Roth, so you can get around the system. Most of the time “rewards or punishments” are meant to act as a buffer to the less fortunate so that they have some help catching up in the wage gap. Again doesn’t really impact why you should save for retirement.

    (4) You may never reap the fake rewards. Then why save at all? Again moot point, whether it is in your 401(k) or your IRA, Traditional or Roth. If I follow your argument and don’t save for retirement at all, there’s probably a 99% chance I’m going to live past 65. I just gave up a significant amount of savings incentive by the gov’t. I’ll take the chance that I live rather than that I’ll die. Even if I die those savings go to my family.

    (5) Withdrawal penalty. – Same thing, 401(k) and traditional IRA both have withdrawal penalties just like Roth. Doesn’t impact decision on Roth basis.

  45. Random Reader says

    Not to be rude to the OP, but most of your arguments are opinions and not facts. They should not impact why you should chose a Roth vs a Traditional IRA, let alone retirement savings.

    FYI for those interested here are the benefits of a ROTH (which albeit I agree is NOT always the right choice for someone)

    https://www.fidelity.com/viewpoints/retirement/nine-reasons-roth

    The reason I chose Roth vs Traditional is because of the no distribution option, meaning you can continue to grow your nest as long as you live. The reason I chose to max out Roth before my 401(k) is that I can invest in any fund whereas in my 401(k) I am limited to my company custodian’s investment elections. (FYI: My company does not match, if it did that would be a different story)

      • Random Reader says

        Not sure how that is relevant, if the argument is opening a Traditional or Roth -> Fidelity makes money on both accounts…

        Additionally, assuming you are able to max out your retirement you can actually put more into your Roth than a Traditional through the backdoor (not really viable if you already have IRA assets, check your tax situation) -> thus saving more. $5,500 after-tax > $5,500 pre-tax. Thus you can grow that money faster through compounding. Now understanding not everyone can max out, so this isn’t true for everyone.

        Didn’t see your Roth post before, but overall still thanks for sharing. Kudos for your blog.

  46. James says

    If you are late to the saving for retirement game then a Roth is the way I had to go. A regular 401k will make me take Minimum Distributions at 70.5 I will surely still be working trying to put money into the account and did not want it coming out until I retire.

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