The Only Reasons To Ever Contribute To A ROTH IRA

Government Pork SpendingIt’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

ROTH-IRA-CONTRIBUTION-LIMITS

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

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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. says

    Hi Sam,
    My wife and I contribute to our Roth’s for the following three reasons:
    1. We will be below the 25% bracket cutoff this year
    2. We do live in a city and state without local or state taxes
    3. War or no war, politicians will have to raise taxes eventually….because they are too weak to keep costs in check. I think the Roth’s tax benefits may go away, but I think that would be after many many other tax increases.

    For us, I consider a Roth IRA tax diversification.
    -Bryan

    • Lucas says

      See my below post for explanation on why Average vs Marginal rates is actually what kills the ROTH. The biggest risk to the ROTH tax benefits would be the shift from income tax towards VAT or more sales tax. Tax diversification is good, but i totally agree with SAM that you should max your 401k first as this reduces income and MAGI which increases eligibility for tax credits, etc. . Traditional IRA and ROTH do not affect MAGI!

    • says

      Hi don’t know Bryan, your statement:

      “3. War or no war, politicians will have to raise taxes eventually….because they are too weak to keep costs in check. I think the Roth’s tax benefits may go away, but I think that would be after many many other tax increases.”

      Is EXACTLY the type of government mind bender they want citizens to think. It’s a heads they win, tails you lose type of mentality from their point of view!

      But it’s all good. Like I said, contributing to a ROTH isn’t the end of the world. At most it’s around a $350 extra cost per year of contribution all else being equal.

      Sam

  2. N Shaffer says

    Hi Sam, is there any reason you are not talking about the backdoor Roth IRA method? You mentioned in reason #1 that is would ok to contribute to a Roth IRA if you had already maxed out a 401k and traditional IRA, however you cannot max out both types of IRAs. Per IRS rules, you can contribute to both a Roth IRA and traditional (as long as you are within the income limits), however, the total cannot be higher than the IRA limit (typically $5500 in 2014).
    Could you possibly revise reason #1 to state that it is ok to contribute to a Roth IRA if you have already maxed out your 401k but do not qualify for the traditional IRA deduction due to income limits? Also, be aware that in the case you maxed your 401k but have a MAGI higher than 129k single 191k married, you can still contribute to a Roth IRA through the backdoor Roth method. The backdoor Roth method involves contributing to a nondeductible traditional IRA and then converting it to a Roth IRA.

    • says

      These are good points, and I have revised the post to provide more clarity in point #1.

      The backdoor ROTH IRA still goes against what I believe since its still paying taxes up front. But if any one of the conditions above apply, then it’s not so bad.

      • Jason perez says

        I don’t understand your comment on the backdoor Roth IRA method with respect to paying taxes upfront. If your income is above the threshold to contribute to a normal tax deductible and above the Roth income limit then you can do the backdoor method. But this is after-tax money already so there is no extra taxes to pay. Frankly it’s a no-brainer.

        I do the backdoor method even if our joint income is below the Roth limit because I can contribute early (say Jan 1 of 2014 for the 2014 contribution, instead of waiting until I file taxes April 2015 and not have to worry if our AGI is below or above the limit).

  3. Nick says

    Active Duty Military
    1. Max 401k every year ( No employee Matching)
    2. Put 5500 into a Roth for the wife and I
    3. Pay down Investment Property about 100-200 monthly

    Roth IRA just makes sense for us, I now by putting roughly 28500.00 away every year will set me up for success.

    I am hoping and praying I get stationed in Texas, Florida or an income state tax state here shortly.

    • says

      Nick, have you looked at the Roth TSP? Might make sense if you have any tax free income (BAH, BAS, Combat Zone Tax Exclusion). Military folks are usually in the lowest tax brackets of their working lives while they serve.

      • dude says

        The Roth TSP has one very serious flaw — you CANNOT withdraw from one or the other of your regulary TSP and Roth TSP. Rather, any withdrawals automatically come from BOTH accounts in an amount proportional to the balance of each account. For example, if you have 50% of your money in the traditional TSP, and 50% in the Roth, and you withdraw $1,000/month, $500 will come from your regular TSP, $500 will come from your ROTH TSP. Far better to max out your tax-deferred, regular TSP, then dump $5,500 into a Roth IRA with Vanguard (if you’re inclined to have a Roth account — which can be helpful if you find yourself bumping up into a higher tax bracket, if you can pull an amount out of your Roth that drops you into the lower bracket).

  4. Lucas says

    I think you touched on this in your other article but you should clarify that Average vs Marginal rates is actually what kills the ROTH. When you contribute you pay at the very top of your tax bracket (your marginal rate), but when you withdraw from a regular IRA you pay at your average rate (assuming like most people you are relying on this as your primary income in retirement). So even if you are withdrawing 100k from your IRAs to live on, you aren’t paying at 25%. You get to subtract off all the deductions, etc, then pay at 10%, then 15%, and then 25%. So while i am in the 25% tax bracket my average federal tax rate is <8%.

    Unless you have a huge side income stream, there is an almost 0% chance of paying more taxes from the traditional IRA.

    I will say that i think it might make sense to plan for up to 5 years of expenses in ROTHs if you are planning on doing a Roth conversion ladder for funding early retirement. However you should definitely be maxing your 401k first if this is your plan.

    • says

      Great point Lucas. And yes, that is exactly right. When contributing to a ROTH, you are contributing based on your HIGHEST MARGINAL TAX RATE. When withdrawing, you are withdrawing from the progressive lowest to highest marginal tax rate, so the tax is lower, like for like.

      Thanks for bringing up this brilliant point from the old post. I will incorporate this point in this post.

      • Matt says

        It has been mentioned in other comments, but the problem I have with this argument is that it is either / or. This seems to be narrowminded to me. I have a 401(k) and a Roth. One of my biggest tax concerns for retirement is the required minimum distribution for the 401(k). (that is, I see it as a task to manage) The Roth is a tool to help me do this: if I want to splurge, or I have a large emergency to pay for, or if I find my spending creeping up into the 25% rate or above, then I will switch from the 401(k) to the Roth for withdrawals. This balance of spending 401(k) up until the 25% bracket is a way to manage the base tax, and I will use other things to manage deductions, etc. to end up with the lowest overall bill.

        A switch from income tax to VAT is a valid threat, but I would have to believe this will not occur in isolation: there will have to be some consideration for Roths if this happens–either a tax credit for Roth withdrawals, or some other equalization. Count on the lobbyists to push for that!

        • Lucas says

          to clarify, having both 401k and Roth is a good thing as well. But you have to prioritize where you save, and how much you do in each.

          My personal recommendations to people are usually to save up this list as far as you can go:

          1) 401k up to company match – free money & decrease on MAGI
          2) HSA max (reduces MAGI, tax free in, tax free out, social security and medicare tax free, and you can save all medical expenses and get those out at any point in the future – even 50 years, and after 59 1/2 turns into regular IRA for withdraws. So basically best of both ROTH and IRA with some slight decrease in flexibility on spending – but who isn’t expecting major medical expenses in the future)
          3) 401k Max – reduce MAGI as much as possible and maximum tax savings
          4) Roth Max – Tax diversification after reducing taxes as much as possible. You can make an argument for regular IRA at this point, but if you can max your 401k & HSA you aren’t going to be too far off with going with a ROTH here.
          5) Taxable accounts / Debt reduction.

          If you have money that can go into item 5 then by all means go for the ROTH. But i have run the numbers many times with many scenarios and Traditional 401k always beats ROTH. You can always more money into ROTH for more flexibility through conversions in years with less spending (which is my plan). But if you can max all of these tax advantaged savings vehicles you are doing great!

      • whoanelly says

        Could you point me to where this was illustrated in a previous post, as Lucas says? Not grasping what you mean here.

  5. Andrew says

    Maybe I’m missing something but I think you left out a key scenario. For folks who have access to a 401k account and make over 69k single, you don’t get to contribute pre-tax money to a traditional Ira. So the option becomes no benefit vs tax free growth with a Roth. In that scenario the Roth is the better option as you get some for of a tax break. Unless I’m misreading the current tax laws and please correct me if that is the case.

    Also, my understanding is that the 5500 annual limit is applied across all Ira accounts and isn’t on a per account basis. So split evenly between two accounts, the most you could contribute would be 2750 per account.

  6. Adam says

    Sam,

    I am confused by point 1. I don’t think you can contribute over 5500 combined to a Roth and traditional.

    I have always thought that a Roth was beneficial for someone without access to a 401K but who still wants to maximize their tax advantaged savings. When you contribute a post tax 5500 to a Roth it is a larger amount than a pre tax 5500 to a traditional.

    • says

      Adam, I’ve clarified point 1. Thanks for bringing this up.

      Care to share the math on a ROTH IRA contribution being a larger amount than a pre-tax $5,500 contribution to a traditional given the max ROTH IRA contribution is $5,500?

      • Adam says

        I assumed the tax rate would be equal for the Roth or Traditional. If you use the 25% rate as an example, to put away $5500 it requires $7333.33 pre tax but you end up with $5500 when you withdraw. For the traditional it only requires a pre tax $5500 but after tax, you only withdraw $4125.

        Again, this only argues for the Roth if you are maxing out all other retirement possibilities and want to put away as much as possible in a retirement account.

        • says

          Great discussion. This is the type of math gymnastics I like to do.

          So for the ROTH, it requires $7,333.33 at a 25% tax rate to contribute $5,500. That is BAD b/c it takes $1,833.33 more to have an equal $5,500 invested in a traditional IRA. The traditional IRA holder can use the extra $1,833.33 before taxes on something else that provides different types of utility, or can invest the proceeds for an additional boost to the $5,500. From this point of view, I say the benefit of being more liquid and having more options (one of the key underlying premises of this post) makes contributing to a traditional IRA that much more attractive.

          The good thing about the ROTH is that the $5,500 principal is left over to withdraw vs. only $4,125 left over to withdraw for a traditional IRA, all else being equal. But all the while during this growth process, the math balances itself out b/c whether you pay 25% taxes up front, or 25% taxes at the end, the amount is the same.

          • Adam says

            I still think if your only goal is to turn $7333.33 into the maximum amount at 59 and 1/2 your best option is to put it all in a Roth. In the case of the traditional, you take the pre tax 1833.33 that you saved, pay the 25%, then invest it until retirement when you pay additional capital gains taxes which were avoided by the Roth.

            I enjoy the math gymnastics as well. Thanks for the responses.

  7. Seth says

    New to the site. Good stuff, quick question:
    Max out a traditional IRA and then a ROTH IRA? I’m confused how that would actually work, do they not share the same $5,500 contribution limit?

    • says

      You are right to be confused, as I didn’t make point #1 clear enough. Based on your feedback, I’ve altered the language:

      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. – See more at: http://www.financialsamurai.com/the-only-reasons-to-ever-contribute-to-a-roth-ira/#sthash.m8mMmLTF.dpuf

  8. Cathy says

    I’m curious about what you think about converting 401K to Roth between the ages of 59 1/2 and 70 1/2. Since I’m planning on scaling back to part time work at around 60, I think my official income will be low enough that I have space at either the 15% or 25% bracket. My plan is to withdraw from the 401K up to whatever the top of that bracket is, and move the funds to a roth, to let it continue to grow tax free. This should help me reduce my RMD’s. Thoughts??

    • says

      You can contribute up to $5,500 to an IRA in 2014, which jumps to $6,500 if you are age 50 or older. However, if you have a workplace retirement plan, the tax deduction for traditional IRA contributions is phased out for individuals with modified adjusted gross incomes between $60,000 and $70,000 in 2014 ($96,000 and $116,000 for couples).

      The tricky thing is whether you will have ENOUGH money to live comfortably if you max out your 401(k) and then try and max out your IRA making under $60,000 a year. It’s definitely possible, but it may not be easy.

      We wrote a post on contributing to a 401(k) and to an IRA on Daily Capital: http://blog.personalcapital.com/retirement-planning/can-contribute-401k-ira/

  9. Ravi says

    I wonder what the present value of no-govt-hands-in-your-pocket-forever by contributing to a Roth? :)

    I am definitely against a Roth if contributing pre-tax and post tax are mutually exclusive. I love the idea of putting in the max to a 401K and then putting the first $5,500 of investments into a Roth. I opened up a Roth brokerage account recently and am looking forward to the tax-free trading for life! :)

      • Taylor says

        I’d like to see something on the Roth 401k as well. Unfortunately I might be messing up twice as bad since I max out a Roth 401k and contribute $5500 to a Roth IRA through the backdoor method. Like you said, I can always reverse course!

          • Taylor says

            My rationale for contributing to a Roth 401k has been for tax diversification purposes. My company matches 1-to-1 up to 9% in my 401k plan. However, the money that the company contributes is obviously pre-tax dollars. I also have a defined-contribution pension plan with my company that will have taxable withdrawals. I currently live in Texas (no state income tax). I should make around $130k this year, but my income should see marked increases over the next 10-15 years. Do you still think that pre-tax contributions is the way to go for me? If so, I could definitely use the extra money to save up faster for a down-payment on my first rental house!

            • says

              Just thought of something. If you work in Texas, and plan to retire in Texas, then the moving for lower state tax argument is mute. Therefore, the argument is to lean more towards maxing out a traditional 401(k).

              But given you plan to buy a rental house, then it’s a little trickier. However, with a $130K income, you should be able to max out your 401(k) and save money for a rental house. I hear TX has some great property for under $300,000!

  10. Ace says

    Sam,

    FYI: Some states do not offer an income tax deduction for 401k contributions (example PA). That changes the math quite a bit.

    California has crazy high income tax rates, so thank god they still allow this deduction (for now)!

  11. ROTHira says

    I make about $48k a year and pay about 15% in taxes. I’m still young and I know I’ll make more money in the future, but probably not more than $89,350/yr when I retire in 35 years. I’m maxing out a Roth IRA every year, but I don’t have a 401(k) at work.

    When determining between a Traditional or a Roth IRA, I figured the Roth made more sense because I will be earning more (and therefore paying more in taxes) in the future. Is my analysis off?

    • Lucas says

      Sounds like you made an assumption, not an analysis ;-). Lower tax rates make it less of a difference for sure, but you should really run the numbers (making sure to account for the difference between marginal tax rate savings on Traditional IRAs and average rate payout on withdraws vs paying full Marginal rate on Roth contributions now).

    • says

      Howdy mate, good self-reflection and scenario for folks who don’t have a 401(k) at work. If you aren’t going to make more than $89,350/yr and are making under $60,000 a year, then I would contribute a traditional IRA first b/c your 25% tax rate is the same. The end result is a wash on taxes, and you keep the OPTIONALITY of moving to a lower taxed state in retirement if you so choose. If you contribute to a ROTH now, you give up all optionality.

      But if you are in the following tax rates, and believe you will make over $36,900 but under $89,350 a year to reach the 25% tax bracket, then I’d contribute to a ROTH IRA. Just make sure you can afford it.

      10% on taxable income from $0 to $9,075, plus
      15% on taxable income over $9,075 to $36,900, plus

  12. Chris says

    I certainly agree with maxing out the 401K first – there are just too many benefits to overlook. Most people who are able to do so have incomes above the threshold for making a deductible IRA contribution. If their incomes are between the deductible IRA max and Roth max and they can afford it, making a Roth contribution makes sense. For those over the Roth 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 (a rather strange loophole currently available). It’s nice to have some tax-free funds available in retirement.

  13. Shaun says

    My argument for having a Roth would be if you’re already taking a small amount of your portfolio and trading stocks with it trying to hit a home run then why not do it in a Roth vs a normal brokerage account.

    My 401k is already maxed out but even if it weren’t I can’t trade stocks in it. Best I can do is a mutual fund that tries to match the S&P. Why if somebody in my scenario also wanted to put a little money on stocks wouldn’t you open a Roth to do so? If I were to hit a home run I have the option of selling and not having a huge tax bill.

    • says

      That is a great point Shaun. If you are a tweener (point #10), then you might as well contribute to a ROTH if you don’t need the money until 59.5 for the flexibility. I guess it all depends on how much time you want to spend stock picking and how good you are at stock picking. I do think it’s worth chasing unicorns when you are young and have time.

  14. Matt says

    Sam, I want to give you my information to see if I am making the right move. Currently I make 50k before taxes, and these are my following deduction:
    HSA – 2800 (+500 from company for 3300 max)
    401k – 5000 (10% + 7% match, this is max they will match)
    Standard Deduction – 6100
    Other – 3000 (pre tax deductions such as health, vision, dental ect.)

    So my taxable wages are roughly 33k putting me in the 15% bracket. I am 24 so I assume I will be making a lot more money throughout my career and expect to be in higher (or at least not less) than 15% bracket throughout retirement. I have maxed out my roth IRA for 2012 – 2014, but I want you input in my scenario I think I made the right choice. Do you agree? If not could you please explain where I am making the mistake as I don’t know every little detail regarding taxes and such.

  15. Kathy says

    Since my husband and I are both retired, we can no longer contribute to IRAs of any kind. We have both traditional and Roth. My concern about a Roth is that even though the distributions are currently tax free, I can easily envision the government deciding someday that 1) they need to tax the distributions simply because it needs the money or 2) it isn’t fair that people who saved in this vehicle has tax free income while others who did not save do not have tax free income. In the name of fairness or leveling the playing field, it will take part of our IRA to give to those who didn’t save. (You can probably detect my politics based on this comment.) I actually like the hiding the money in the mattress scenario you described. Gold, anyone?

  16. says

    Maybe I’m misreading the IRS website but I’m choosing to contribute to a Roth beacuse with a traditional IRA I will get no tax deduction beacause my modified AGI will be over 70,000.

    At least with the Roth I will still be getting some tax benefits in the future. But if I contribute to a traditional IRA I get no tax benefit now and no tax benefit later, so what’s the point!

    It’s surprising that everyone talks about the basics of the Traditional IRA versus Roth IRA, but most people fail to mention that after a certain income the Traditional IRA gives no tax benefits!

    Maybe I’m reading it wrong but here’s the IRS website with that detail.

    http://www.irs.gov/Retirement-Plans/Plan-Participant,-Employee/2014–IRA-Contribution-and-Deduction-Limits—Effect-of-Modified-AGI-on-Deductible-Contributions-If-You-ARE-Covered-by-a-Retirement-Plan-at-Work

  17. says

    I opened a Roth IRA very early on in my career when I didn’t have access to a 401k. I was thrilled when I switched companies and got access to a 401k with company match.

  18. JW says

    Did I miss the part where you say it’s OK to contribute to a Roth IRA if your combined (married filing jointly) income exceeds $191k AND you’re going to do so through an Traditional IRA conversion into a Roth?

    I realize that this only makes sense when one can’t get the tax deduction from the Traditional IRA contributions AND that each Trad. IRA dollar converted is considered by the IRS as being part contribution that received a tax deduction and part contribution that did not receive tax deduction, equal to how your total Traditional IRA balance is split.

    For many of us though, this is the only way to get some tax deferral benefit off of our next retirement savings dollar.

  19. Tyler says

    Would this approach change at all if you wanted to retire before 59.5? I am planning on reaching finical independence by 40 but want to access my funds to support that independence. So as a result, I am investing in an IRA and separate index funds to support my early retirement. Should I focus more on my 401K?

  20. says

    This is kind of a weak reason, but people may end up saving more in a Roth than a Traditional IRA, simply because one uses post-tax money. To really take advantage of the Traditional IRA, people have to also invest the extra in-year income gained from the tax deferral. I’m not entirely sure a lot of Americans will take this extra step, as we’re not particularly good savers. For people who aren’t natural savers and are likely to just invest the same $5,500 pre-tax or post-tax, you might be better off with the Roth.

    I’ve been pondering a switch to a traditional IRA for a while, but keep on contributing to my Roth out of habit. Does a bad habit count as a reason?

  21. Kathy says

    Here is a scenario in which Roth makes sense: You make very little money now, so you’re at the lowest tax rate, but you stand to inherit a fortune, which will be taxed at the highest rate.

  22. Ace says

    Sam,

    There are some estate planning benefits to a Roth IRA.

    Also, there are no mandatory distributions at age 70 and 1/2, and Roth distributions do not affect tax ability of Social Security benefits.

    You have already covered the flexibility of withdrawing your contributions without penalty. This could be an important option for folks that get into a sudden liquidity crisis.

    If you are a disciplined person, I think having greater control of your money and the flexibility to choose almost any investment is much better than a typical company 401k plan. But then again, I’m a finance/investment guy, so what works for me, might not work for the typical American. For most people, the automation of 401k plans is the best.

    In regards to the option of moving to a low tax (or no tax) state: That’s not likely. The vast majority of folks will get settled in their current state, in regards to friendships, family, etc. The older you are, the less comfortable you will be with moving out of your home town/state, to a strange place, just to save a few bucks in taxes. I haven’t seen or heard of too many millionaires moving from California to Wyoming! Not that there is anything wrong with Wyoming. It’s just too huge of a culture shock for someone whom has spent their entire life on the west or east coast.

      • Ace says

        Well…. You certainly can’t be whining about severe cold winter weather if Jackson Hole is your intended home.

        It’s a ski resort area with a population of about 21,000. Not much different than Aspen or Park City.

        Yes…. You run into a few wealthy people on the slopes, whom are visiting for a few days. But, not exactly a mass movement to relocate!

        Now Florida…. That’s different. And Texas has possibilities. But again….. People have considerable inertia. If you spent the last 40 years of your life in SOCAL, it is going to be very difficult for you to pick up and move. I don’t think lower taxes are as high of a priority for most folks.

        • Ace says

          So along that line of thought: Since a resident of a high tax state (such as California) is likely to remain in his/her state during retirement, there is an implied tax advantage to the Roth IRA. 30 to 40 years of successful (hopefully) investment returns being withdrawn tax free. Whereas, all 401K distributions will be taxed by both the IRS and likely the state.

    • Joel says

      As ACE points out there is no required distribution with a Roth as there is with a traditional.

      So another reason to have a Roth – you plan on never needing the money and want to pass it on to your heirs completely tax free, this is why I have a Roth. I know, I know, why save it if you don’t need it, no one would do that etc… Sometimes it makes sense, you have a great pension, you have a special needs child, you have several children, you just hope to stick it to the government….

      Of course, I recommend converting from a traditional to a Roth once you stop working so you can enjoy the tax break the traditional provides you.

  23. says

    Hi Sam,
    I really enjoyed this post…I have been reading your blog for sometime and finally have the courage to comment.:-)
    So, my company has this mysterious profit-sharing plan and we really have no idea if/when it will fund. When it does happen, and we get a report, it’s like Christmas.
    For someone like me, with no 401k, would a Roth be your recommendation? I fall in the middle class tax bracket.
    Thank you!
    Catina

    • says

      Hi Catina,

      It depends on your beliefs about future income growth. I would say traditional IRA first.

      “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.

  24. Trailwise says

    Hi Sam,
    I found your website while researching the differences in IRS. I recently retired and need to do something with my 401k account. I will be 62 this summer. I know my income will be less in my remaining years. I plan to only work part time if at all. So from what I gather from your article I would be smarter to roll the money into a regular IRA and keep my fingers crossed that the tax rate doesn’t increase significantly before I die. I live in Texas.
    I am looking forward to receiving your newsletter.
    Thank you

  25. StevenC68 says

    Hey! great article and timing; I’ve been working on testing the waters for 2 (TWO) Roth IRA’s and an HSA.. would love to hear your opinion.

    Married Filing Jointly / Wife is a stay @ CEO MoM
    Fully Funded 401k
    Current Spousal IRA Traditional (already contributed 2014) – 40ish -k
    Current Personal IRA Traditional (no contributions, it’s left over from the past) – 75ish -k
    Current Roth IRA (just started it this year, contrib’d 2013 & 14) – 11ish -k
    HSA – not started yet, Sept 2014
    Want to start a ROTH for my wife and no longer contribute to the traditional.

    this gives me about
    1935/mo or 23220/yr going into a tax deferred 401k
    916.66/mo or 11000/yr going into an after tax / tax free withdraw
    xxx.xx/mo or max/yr going into HSA

    My assumption is; I’m 45 now, I live in Washington, my 401k/Traditional IRA account(s) should be enough taxable money, my thought was to have some tax free money for any surprise expenses, whether it be medical (Roth + HSA) or something crazy, like a late life crisis and I need a motor cycle or dune buggy, or land rover and run through the desert…

    Anyway – the short is, I was considering two ROTH’s instead of one… thoughts?

    Steve

  26. Jonathan says

    I’ve struggled back and forth with the Roth multiple times. One advantage of the Roth over the 401k or traditional IRA is in a scenario where you happen to make outsized earnings. If your post tax 10,000 contribution into a unicorn stock turns into 150,000 over a period of time, all of that gain is tax free in the Roth. If I put pretax 10,000 into the same unicorn stock, I would save maybe 3000 up front but all of that gain would be taxed when I withdraw.

    This is a scenario where the Roth would be great. I’ve read most of the comments in your older Roth article and this one but no one seems to mention this. Did I miss something or is this just common sense to everyone already?

  27. Lance says

    What about the fact that most of your investments for retirement are in growth and not contributions?

    Lets say you are in the 25% tax bracket and you invest $5,500 in a regular ira and $5,500 in a roth ira. It returns an average of 10% (average of the stock market) for 40 years.
    Initial Tax savings for regular ira = 5500* .25 * 40 years = 55000
    Initial Tax savings for a roth = 0

    Both account increase to $2,677,684.96 (I used moneychimp.com online calculator, 5500 annual addition, 40 years to grow, 10% interest rate, compound 1 time a year)
    Tax due for the regular ira = 2,677,684.96
    Tax due for a roth ira = 0

    Lets just assume the tax rate is the same 40 years in the future as it is now, even if you only take out the required minimum distribution and you pay 10% tax (the current lowest tax rate). You will then owe 2,677,684.96 * .1 = $267,768

    So in effect you paid $55,000 in roth ira (from the taxes you didnt save at that time) vs paying $267,768 in a regular ira. Even factoring in inflation how is over $200,000 more in your pocket a bad thing?

    I dont have an employer match at my work, but me and my wife have been maxing out both our roth ira’s and plan to every year for 40 years. Anything extra will go either in a 401k or extra payments to house

    Please let me know if any of my calculations do not sound right.

    • Ravi says

      Your math is flawed.

      You have to think in equivalent dollars. In order to contribute 5.5K to a traditional, you need to earn 5.5K. If you earn 5.5K and want to put it in a Roth, you only get to deposit $4,125 (5,500 x (1-25%)).

      Now do the same math.

      Traditional: 5,500 * 1.1^40 = $248,926
      then multiply by equivalent withdrawal tax rate (1-25%)… aftertax equivalent of $186,695

      Roth: 4,125 * 1.1^40 = $186,695

      The aftertax value on day 1 of retirement is the same in either case. The only way they differ is if your tax rate goes up/down.

      • Lance says

        I understand your point, but I am actually putting in $5500 in a roth ira, not $4125. Putting in $5500 in a roth is essentially savings more than putting $5500 in a regular ira. Im also in a low tax bracket now so the income tax savings is low right now. Im actually going to convert an old ira into a roth this year at only 15% tax bracket.

        • says

          To put $5,500 into a ROTH, you must earn about $6,500 at a 15% marginal tax bracket. Hence, it costs you $1,000 to get the equivalent of $5,500 in traditional IRA buying power.

          I see that I have failed to sway you from converting to a ROTH. But that’s OK, as this country needs as many tax payers as possible now due to our budget deficit.

          I am torn, b/c the reality is I would like EVERYBODY except for my little community to convert to a ROTH to pay more taxes to LOWER the chances tax rates will be raised for the rest of us, and INCREASE the chances that wealth gets distributed to those who don’t pay taxes.

          • Lance says

            Oh, I also get a $200 tax credit for putting money into a roth since i am under the income. See tax form 8880. So I essentially pay $800 in tax this year and it will grow to $248,925 tax free. Or i could leave it in a regular ira and pay 15% tax on that when I retire. Makes a lot of sense to put it in a traditional says the $36,000 I save in tax this way.

  28. Ace says

    Sam,

    The comment sections are the best part of your blogs. You do a great job of presenting a topic with your point of view, but it really helps when you have active commenters with various thoughtful view points.

    My conclusion is that from a tax point of view, Roth or 401K are basically a wash if your investments are typical mutual funds (or even index ETFs, which are rare in 401k’s). Income tax rates are at a historic low and I would expect them to move higher going forward. The Roth could be a help there.

    The real real advantage of the 401k is more psychological. It’s automated. Contributions are done at a small painless amount out of each paycheck (for most folks), so people of course get accustomed to a certain net pay. So life then is good. You go buy your morning coffee from Starbucks every day, while every two weeks, you are dollar cost averaging into whatever mutual funds your company provides.

    IRA’s require more of an active effort to contribute. A zillion life problems seem to pop up, preventing contributions. And of course, IRAs require more thought in investment choice. The average person just doesn’t have the ability to put much research effort into various investments. So…. For average people, 401k’s win!

  29. says

    Active duty military with frequent tax free deployments. Last year in the 15% bracket with 1.9% effective tax rate.

    Full contribution to Roth TSP (government/military version of Roth 401k) and full contribution to my wife’s and my Roth IRA. Money is going in barely taxed, growing untaxed, and will be withdrawn untaxed after age 59.5. Plus, TSP has the lowest expense ratios of any index funds around.

    If you’re in the US military and getting tax free income, you must capitalize on this! Also, much of military pay is untaxed allowances (housing and food allowances), so even if you’re not getting tax free combat deployments, you’re still in a lower tax bracket that what your income actually is.

    Not all of us are in the 39.6% bracket, Sam. :P For some of us peasants at the bottom, the Roth 401k/TSP/IRA is actually a pretty good retirement plan. Thanks for another thought provoking article.

    • says

      Sounds good to me! And I’m not in the 39.6% bracket either. Totally down with joining half of America! :) I plan to not go back, which is why contributing to a ROTH is out of the question!

      • Bryan says

        I’m in a similar situation as Spencer. I am a married (w/ 1 kid), full time dental student, serving part time in the Air National Guard. Since I’m currently paying zero in taxes, I’m dumping all of my pay and bonus into my TSP Roth. I’m glad I’m not the only one. Once I graduate and start working as a dentist, it’s back to my traditional TSP. :)

  30. Ricky says

    Regarding a regular 401k vs roth 401k, isn’t the main idea choosing between the two determining if your current tax bracket will be higher or lower when you retire? So if you plan to be in the same or higher tax bracket when retiring the roth 401k makes more sense.

    I did an example of a gain of 5% annually, contributing $5000/yr, 28% tax rate.

    After 10 years:

    Contribution (pretax) = 45000
    Contribution (aftertax) = 32400
    Roth (pretax/aftertax)= 50398.76
    Regular (pretax) = 57889.46
    Regular (aftertax) =41680.41

    Is my analysis wrong?

  31. Al says

    Very interesting post.

    Sometimes difficult to follow the mathematics :)

    What do you think about my plan?

    I have been working for 12 years, my income gradually increased until it reached a plateau around 280k for the last 5 years. I have other investments also.

    I have aprox 500k in 401k and 457 plans (aprox 30k/year) and I did “regular” IRA then converted to Roth IRA (presently around 120k total) , thinking that when I retire I can use the Roth IRA if will need at one point more money for a year and this way my tax will not increase then. It is true , I pay high taxes upfront but I prefer to save as much as I can now and then the money in Roth IRA will grow tax free and when I withdraw I don’t have to pay taxes.

    Any thoughts?

    Thank you.

    • says

      If you think you’ll continue to make over $280,000 in retirement, then you made a neutral move.

      And if you plan on making less than $280,000 while retired, you can just attribute the extra taxes to patriotism!

      • Al says

        Thank you for the reply.

        I was thinking a little more about this. I contributed every year to this Roth IRA (traditional and then converting to Roth IRA, pretax money, true, but the conversion didn’t cost me anything, it was done in approximately one year after depositing the money). I created 120k brokerage account that whatever I do with it, I will not pay taxes again on it. It must be better than having that money in a brokerage account that is not Roth? Do I miss something?

        Obviously I maxed out my pretax contributions before I did this.

        If the opinion is still that is patriotism paying the taxes on it, so be it!

  32. Marcus says

    You forgot #11.
    You can no longer max your 401k because the company you work for states you are a HCE (highly compensated employee) at $115k. Now my 401k contributions are capped at 10%. Unfortunately my wife and I are at the brink of the $191k phase out for Roth contributions!

    Your thoughts? I think this post needs a follow-up for those that are over the arbitrary $191k threshold.

    • Matt says

      Marcus,
      You can still recharacterize! It will cost you extra paperwork to do so, but is otherwise painless. You make a non-deductible traditional IRA contribution, recharacterize it to Roth, and pay taxes on it. (wait! You already did! As long as you move quickly, and don’t otherwise invest the money in the meantime, this is at or near $0) and, voila!

      Note that this can get tricky if you have other IRA’s (not 401(k)’s) as the taxation will be in proportion to all of your IRA’s, not just the account you recharacterize. But, of course, see your financial professional to be sure.

  33. says

    I’m not going to be much help in contributing to these comments- but I sure as hell am learning a ton. As I’m basically understanding it, since my wife and I earn under 90k, we should be maxing out our traditional employer sponsored 401(k) plans first, then the HSA, before we even think about touching a Roth?

  34. Jordan says

    35 years old, Maxing out 401(k) and HSA with annual household income of 275k. Never had IRA or Roth until 2 years ago. Established both and currently contribute annual max to IRA for my wife and I and then immediately convert to Roth, thus producing no tax. This strategy was recommended by a financial advisor. Is this an appropriate use of the two devices?

      • Jordan says

        Thanks for the quick response! We have about 200k in taxable accounts and contribute approximately 15k a year to those accounts annually as well. New to you webpage and like the content. Thanks for all the great content.

  35. says

    The thing that frustrates me most is that my household income exceeds the limit for investing in a traditional IRA. I believe I make a nice income, but it isn’t like I’m sitting on my yacht eating caviar. It just doesn’t feel right that my income is triggering essentially the loss of a retirement benefit.

    I guess the implication is that I can “afford” to save for retirement without getting a tax credit for it right now. Tell that to my student loans that I’m diligently working to pay off… someday.

  36. KC_Masterpiece says

    I am earning about $70k and have been contributing up to my company’s match to fund a roth 401k. I work in NY. Am I doing it wrong?

          • KC_Masterpiece says

            Yup, I’m in my late 20s, worked at one company (financial services) right out of school, but recently took a pay cut and joined a non-bank to get some work life balance and to get my masters.

            I’d like to retire early though, I don’t see myself working into the 60s.

  37. Jim says

    I recently set up a Roth IRA for my niece and funded it with $5,500 for 2013. She is graduating college soon, and earned about $6,000 to $9,000 last year from summer and part-time jobs. Depending on whether her prospective employer offers a matching contribution 401-k, and she’s vested this year, and how much of her income is taxable for 2014, will determine whether to add to it for 2014, open a regular IRA, or stick to the 401-k. Is this another good reason to fund a Roth IRA, at least for one year?

  38. Jared says

    Me and my wife have been maxing out our Roth-IRAs the past few years.

    Here is our info:
    -Both Age 30
    -Both expect to retire early 50’s with 60% of average highest 2 years of salary as a lifetime pension benefit (with increases built in to keep up with inflation)
    -Currently, $90k combined AGI
    -25% Bracket
    -No debt, but expect to take on a mortgage over the next couple years
    -I max out my employer sponsored HSA (recently decided this should take priority over IRA since HSA contributions reduce FICA taxes; funds can be withdrawn at age 65 for non-medical, making it similar to a Trad IRA…)
    -We both max out our Roth IRAs (@ Vanguard) rather than Trad IRA
    -No 401k option, but we do have access to 403b/457b (no employer matching)

    Given our circumstance, are the 2 reasons below not valid reasons to consider a Roth IRA over a Traditional IRA?

    1. Ability to withdraw contributions out at any time, without penalty (vs 10% penalty in traditional IRA; allows flexibility to pull money in the event of opportunity / emergency penalty free; allows us to pull funds in early/mid 50s if we want to supplement other income sources penalty free)

    2. Tax diversification (no way to know future tax structures; other sources of retirement income will be taxable; our pension plans will (or should) provide lifetime taxable income)

    • says

      Hi Jared, with no 401k or 401k matching, maxing out each of your Roth IRAs is not a bad choice. But what about the traditional IRA and what you expect in future income?

      At a 25% marginal tax bracket with much limited income upside, I think you’ll be paying lower taxes in retirement.

      I would eradicate the notion of withdrawing contributions, b/c that defeats some of the purpose.

  39. says

    Being in Silicon Valley, last year is only the second time in my career I’ve been able to contribute to a Roth IRA. Both times were when I was laid off and unemployed for several months.

    Typically, I max out my 401k and make a non-deductible contribution to my traditional IRA. It’s not as nice as a deductible contribution, but at least the gains can compound tax-free.

    Holding non-tax-sheltered investments is painful come tax time, but I also keep some of my investments outside my retirement accounts so I’m not completely dependent upon the government giving me my retirement funds when I need them. Tax shelters are nice, but freedom feels better.

  40. Green_Knight008 says

    Based on my calculations with the following assumptions:
    Tax rate, ROI, and income are static, and that the tax savings of a traditional deposit is invested at the same ROI instead of spent.
    A Traditional outperforms a Roth starting in year one.

    It takes a mere .5% increase in rate of taxation to reverse this trend. If you’re investing in a Roth, you’re essentially assuming that at some point between your investment and your retirement that there will be a .5% increase in your rate of taxation. For a lot of people this actually seems to be a pretty safe bet-particularly those who are young and below their earnings apex. Perhaps not quite as safe a bet for someone nearing retirement age.

  41. says

    Thanks for the article, Financial Samurai. It really made me look through the reason why I invested in a Roth IRA. Ultimately, I decided that it is still the best for me because I’ll be in a substantially higher tax bracket a few years from now and will only be able to contribute to a non-deductible IRA. For those reasons and for the fact that there are no RMDs, I’ve decided to stay with a Roth for the time being. I wrote about it in more detail on my website.

    As far as what Jared said a few comments above about withdrawing contributions, if you only withdraw what you’re receiving in dividends, the overall income generating ability of the Roth portfolio would the same. I go into more detail about this as well on my site.

    Thanks again.

  42. says

    This has to be the first article I have ever seen daring to go against the Roth IRA and you do bring up some good points. Just as you recommend, I did max out my 401K yearly and then also contributed $500 a month to a Roth IRA from 2000 to 2009 when I retired at age 51 and just let the Roth ride. As I take comfort in knowing I now have $100K or so “supposedly” tax free in the Roth, after reading your post I wonder had I made these contributions to a traditional IRA along with the taxes I paid going the Roth route, what would I have in the traditional IRA account now by having the tax money I paid also compound and gain. To keep it simple and including my state tax rate, $500 + 30% (taxed rate) = $650 a month to a Traditional IRA vs. the $500 I contributed to a Roth, both having the same monthly out of pocket financial weight to me. Something to ponder as now my tax rate is lower than it was all those years and who knows what it will be in the future. I would have liked to have seen this article in the year 2000 when I was trying to make the traditional vs Roth IRA decision. Once again you have written a thought provoking article. Thanks.

    • says

      Hi Tommy,

      Glad you enjoy the other side of the story. The government and the brokerage community are aggressive backers for good reasons. Saving in a Roth is better than not saving at all at least!

      Sam

  43. Chriva says

    Best use of the Roth is for establishing a retirement account for your children. You can establish a Roth 401k for a child with you as the custodian until they hit 18. Unless your kid’s a super successful child actor or model – chances are his/her meager earnings are not going to be subject to taxes going in and will be tax free coming out. Better yet if you own your business you can expense their earnings as wages and reduce your tax burden as well – obviously you’ve got to have the child do real work (i.e. W2 reportable wages) – but having them star in an advertisement is legitimate work. 60 plus years of compounding…

  44. Jay says

    I’m surprised no one has brought up a doctor’s tax situation and the benefits of having a Roth.

    I am currently a radiology resident in NYC making ~65k/year for the next few years. Once I graduate, my income will increase 5-fold. I think in this situation, likely for any medical resident, it makes sense to contribute to Roth IRA/401k when in the “low” tax bracket, because they will most likely never again be in this low a bracket again and will undoubtedly contribute to a 401k/IRA during their peak earnings year.

    Tax diversification is always a good thing, especially in retirement!

  45. Tom says

    Wife and I make combined income of 210k /yr . I’m 32 , she’s 28. Wife just changed jobs. Has 15k in old companies 401k. Thinking about either leaving it in the exisitng 401k account (it has lots of options and .5%maintenance costs annually), converting to her existing company 401k (which I don’t like since the options suck and expenses are high), converting to traditional IRA or Roth IRA. If Roth, I get taxed at 28% right off the bat. But I like the idea of tax diversification. Not sure what to do. What makes the most sense?

    • Matt says

      Tom,
      Since you are asking…

      Note that, if you convert to Roth, you have to come up with the $4,200 in cash yourself, immediately–if you thought to use some of the $15k for that, then that is considered a withdrawal, and will also be subject to the 10% additional penalty. In fact, what will likely happen is that the 401k will short-change you $4,200 (i.e. withhold the taxes) and you will need to find it, to deposit along with the rest.

      Happy thought #2: the .5% maintenance is .5% more than your IRA would charge. I don’t know of a 401(k) with such an advantage in investment options that it is worth that much. If you are generally indexing, then that’s an outright ripoff. (For reference, my very large employer’s fee is .11%)

      If you want to diversify your tax treatment (which I do think is a smart thing) I would suggest you start your new contributions into a Roth 401(k) or Roth IRA.

  46. DSchulz says

    I love the combination of this post and the “disadvantages” post. Gives a good two directions approach to your advice regarding “to ROTH or not to ROTH”. I hope to read more of your articles in the future. Sadly I have chosen to ROTH, a little. My employer 401K plan now has a ROTH option they just rolled out in October 2014. I am about 1/3 of the way into my career, and have a high earning spouse, but LOTS of expenses (daycare, investing in a business, mortgage). I am contributing beyond the employer match but see no horizon where I can max out the $17,500. With the high earning spouse younger than me likely working for 3-5 years afters I retire, and the hope that the business will be providing retirement income some $ in ROTH 401(K) makes sense to me. Good Luck to us all!

  47. says

    Oops, just saw that you did point that out in item #1. Sorry ’bout that my friend! :-)

    That’s what I get for reading it on my phone while doing homework with the kiddos.

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