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. But just so you know, the math also depends on the future performance of your investments. Let’s say you pay $2,000 in taxes to contribute $5,000 to a Roth IRA, and that $5,000 miraculously grows to $1 billion dollars. Your total tax bill will be around $500 million dollars! Trust me, I was a rock math star in the 2nd grade!
Sam, I can appreciate your distaste for the USG, but your math is all wrong. You convert $50k from an IRA to a Roth IRA, and pay your taxes. Ten years later, at say 7% annual growth rate, that $50k is now over $98,357. I pay no taxes on that $48,357 increase. In a regular IRA, I would owe taxes on that gain.
Sure the USG wastes our taxes, but with a Roth they have less to waste!
* What will $5,500 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 $18,000 for 2015), 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 $5,500 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% (as of 2Q2015), you need $6.1 million dollars to generate $122,000 a year in income!
You will likely NOT make more in retirement than during your working years. Stop being delusional!
2015 INCOME TAX BRACKET – GIVE ME MORE OF YOUR MONEY!
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
The best way to build wealth is to get a handle on your finances by signing up with Personal Capital. Be the captain of your own ship. They are a free online tool which aggregates all your financial accounts on their Dashboard 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.
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 in 2Q2015