It’s been a while since I published, “Disadvantages Of A ROTH IRA: Not All Is What It Seems” and since that time, hundreds of thousands of folks have decided to think more carefully about their retirement savings strategy. One of the main things people have learned is that the government manipulates individuals into forking over more money than they otherwise should due to gross mismanagement of their own budget. Massive deficit? Let’s announce this huge “benefit” to allow people to convert their pre-tax retirement funds into a ROTH IRA! We’ll raise the spectre of higher tax rates to get more people to bite.
It’s sometimes daunting to go against the government because they employ some of the smartest people on Earth to keep themselves in power while keeping the rest of us dependent on their largess. But I’m here to help you fight back and live a better life.
If you contribute to a ROTH IRA or convert your pre-tax retirement accounts into a ROTH IRA, you aren’t going to be damned to hell. You’re just not maximizing your wealth over time. I’m a rational person who likes to see both sides of the story. So let me share with you the only legitimate reasons why one should ever contribute to a ROTH IRA.
For those of you who already have a ROTH IRA account, what you are about to read probably makes so much sense you might feel a little bad. But don’t worry. The number one solution when you are in a hole is to stop digging and slowly climb out.
THE ONLY REASONS TO EVER CONTRIBUTE TO A ROTH IRA
1) You’ve maxed out your 401(k) already. If you’ve contributed $17,500 to your 401(k) and $5,500 to your traditional IRA (only possible for individuals making under $60,000 or married couples making under $95,000), then go ahead and contribute to a ROTH IRA for tax diversification purposes. This is a trick statement because once you’ve maxed out your traditional IRA of $5,500, you can no longer contribute to a ROTH IRA. What you can do is split the $5,500 between a traditional and a ROTH to diversify your tax liability. Even if I tell you that tax rates aren’t going up for the middle class because greedy politicians need the middle class to keep them in power, I don’t know for 100% certainty that people making less than $200,000 a year won’t see higher taxes in the future.
2) You’re in the 25% marginal income tax bracket or lower. If you earn under $89,350, you are at most in the 25% marginal federal income tax bracket. The 25% tax bracket ranges from an income of $36,900 to $89,350. (The 28% tax bracket is from $89,350 – $186,350 and the 33% tax bracket is from $186,350 – $405,100). It’s not good enough to just be in the 25% tax bracket or less, because you are in the absolute sweet spot of middle class America where you will likely never be a target for income tax increases. You must also be absolutely BULLISH about your income prospects. If you are a young person who is a superstar at your firm with income visibility over $89,350 then feel free to contribute up to $5,500 to a ROTH IRA now because you will be completely creamed by the IRS in the future. If you are a late bloomer who is finally on track to maximizing your potential, then contribute to a ROTH IRA. Just don’t forget to continue maxing out your 401(k) during this time.
3) You’re going to make over $129,000 or your spouse is getting a big raise. After you make over $129,000 as an individual or $191,000 as a married couple, you can’t contribute to a ROTH IRA. It is still unknown how the government comes up with such arbitrary amounts, independent of location. Don’t they know that San Francisco is much more expensive than Des Moines? Contributing to a ROTH IRA is particularly useful for those who are on the hunt for sugar mammas or sugar dads. If your prey actually proposes, then contribute as much as you can during the engagement before it’s too late. (See: Should I Get An MBA To Find A Wealthy Spouse? and Stay At Home Men Of The World, UNITE!)
4) You think World War III is on the horizon. If you think world leaders no longer respect the United States’ might (e.g. Russia taking over Crimea, Ukraine) and plan to invade, conquer, and bomb neighboring countries around the world, you should consider: 1) withdrawing all your money and keeping it under a mattress, 2) make sure your savings accounts are no larger than $250,000 for an individual or $500,000 for a married couple to comply with the FDIC guarantee amount, 3) sell equities and keep cash, 4) or contribute to a ROTH IRA because the government will likely raise taxes on everyone to fund a long war. I still think if you make under $200,000, you’re relatively safe. However, with an expense as large as World War III, the government may have no choice but to raise taxes on people paying 25% or less.
5) You feel tremendous guilt for not paying your fair share. Let’s say you’re having a guilty conscience for not paying enough taxes because you either cheated on your taxes for years, run a cash only business with two sets of books, mooched off the government longer than you should have, or feel so bad taking advantage of all the loopholes, then go ahead and contribute to a ROTH IRA. I’ve spoken to a lot of the 47% who don’t pay income taxes during my time off from Corporate America, and a couple have admitted they feel bad that 100% of the tax burden is paid for by only 53% of the people. Many of my 47% friends have side jobs that are cash only and never pay taxes.
6) You’re undisciplined and expect to have a lot of problems in your life. You may have the best intentions of saving for your retirement, but you know that you have poor discipline when it comes to money. Perhaps your experiences as a relapsing cigarette smoker or drinking alcohol have given you doubt about never needing to raid your retirement accounts. Maybe you’ve got outstanding debts that must be paid or else goons will visit you in the parking lot and break your kneecaps. Who knows. The “good” thing about a ROTH IRA is that you can withdraw the money you put in penalty free, just not the earnings. The only times you might be able to get away with the early withdrawal penalty before 59.5 is if for college expenses, medical expenses greater than 7.5% of your adjusted gross income, or paying for a first-time home purchase (up to $10,000).
7) You have inside information knowing that ROTH IRAs will get favorable treatment. Let’s say you work in the US Treasury and overhear that the government plans to pilfer all 401(k) and traditional IRA accounts by raising taxes on withdrawal rates and extend the penalty free age of withdrawal from 59.5 to 69.5. You’ve seen draconian measures executed with bank deposits in Greece in 2013 so you have no doubt America can do the same. You also hear that anybody who contributes to a ROTH IRA will get a one-for-one dollar match and get two votes to raise taxes on others to benefit yourself. Clearly you should contribute all you can to a ROTH IRA until the government changes its mind again.
8) You live in one of the no state income tax states. Federal income tax is one thing, state income tax is another. If you live in Texas, Washington, Florida, Alaska, Nevada, South Dakota, Wyoming, or New Hampshire, it is less of a sin to contribute to a ROTH IRA because you aren’t paying any state income taxes. Everybody else should figure out a way to retire in one of the seven no income tax states and then start withdrawing pre-tax retirement funds.
9) Someone is paying you to promote a ROTH IRA. Money makes people do anything. If some organization is going to pay you to promote the ROTH IRA then I guess you’re better off than others who don’t have the same money making opportunities. If you can earn more promoting the ROTH IRA than what you can earn from the returns of your ROTH IRA, then you would be a fool to ignore all the wrong reasons for contributing to a ROTH IRA in order to pad your bank account. Be especially aware of financial advisors or CFPs who aggressively push the ROTH IRA without providing other benefits besides tax free growth and gains. Make sure pitchmen practice what they preach. (See Questions To Ask Before Hiring A Financial Advisor)
10) You are an income tweener. If your income is between the deductible IRA max and Roth max ($60,000 – $114,000 for individuals) and you can afford it, making a ROTH contribution could make sense. For those over the ROTH income max, you can do a “backdoor” ROTH contribution – by making a non-deductible contribution to a traditional IRA and then converting it to a ROTH.
CONTRIBUTION LIMITS BY INCOME FOR THE ROTH IRA
As you can see from the chart, if you make over $129,000 as an individual or $191,000 as a married couple, you can no longer contribute the maximum $5,500 to your ROTH IRA. The government deems any income above such amounts is enough for you to find alternative retirement savings options besides the 401(k). Fair enough for the majority of Americans. Not so much for folks who live in cities where the median priced single family home is over $1 million dollars.
CONTRIBUTING TO A ROTH IRA ISN’T THE WORST THING IN THE WORLD
Mathematically speaking, the most taxes you will pay on a $5,500 contribution is roughly $2,150 ($7,650 X 28% tax bracket). You can’t contribute to a ROTH IRA if you make higher than a 28% tax bracket ($189,000) as you see in the chart above. So for those of you who think you’ll be making more than $189,000 a year in retirement and are afraid to pay a 33% or higher federal tax rate, good luck to you. I’ll be petting my unicorn before we go off on a ride in the clouds.
Even if you do end up making over $189,000 as an individual or $226,850 as a married couple in retirement to reach the 33% marginal tax bracket, the most extra you will have to pay is 5% (33% – 28%) when you withdraw money from your 401(k) or traditional IRA. That’s $382 for each $5,500 pre-tax contribution. $382 is hardly a big deal at all because you’re living large in retirement while feeling good you didn’t feed a wasteful and corrupt government for all these decades.
If the choice is between not saving anything at all and saving in a ROTH IRA, then definitely save in a ROTH even if you haven’t funded your 401(k). But now that you’ve read this post, please just max out your 401(k) and traditional IRA instead of contributing to more government waste. Hold on to your money for as long as possible. Never give up until the very end!
RECOMMENDATION TO BUILD WEALTH
* Analyze your investments for excessive fees. Whether you have a ROTH IRA or a traditional IRA, I would sign up for Personal Capital to run your retirement fund through their Investment Checkup tool for free. You’ll get a snapshot of how much in portfolio fees you’re paying a year and how you can optimize your portfolio based on your risk tolerance. Personal Capital also tracks your net worth and your cash flow so you’re always building your wealth over time. I’ve been using Personal Capital since 2012 and like their product so much that I decided to go work for them starting in 2014. The tools are free and it only takes a minute to sign up.