Although the Roth IRA is an important tax-advantaged retirement account, there are also disadvantages of the Roth IRA that are seldom discussed. This ends now in this article that I wrote during the Obama administration and have now updated during the Biden administration.
For years I’ve been an opponent of the Roth IRA. After the government came out with its tricky way to let us all do a “one-time” Roth IRA conversion from our traditional IRAs, I knew something was up.
The government was so successful in getting people to pay huge sums of taxes on their IRAs up front during the financial crisis that I just shook my head in disbelief.
With so much stimulus spending to fight off the global pandemic, I’m afraid the government will do the same thing. The government needs to find a way to raise taxes. And President Biden is on a mission to do just that.
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).
Contributing To A Roth IRA Is Better than Not Saving
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 more 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 the way to go.
Please read all the disadvantages of the Roth IRA to keep an open mind. You can contribute to a Roth IRA if you are in the 24% federal marginal income tax bracket or lower. However, there are strong arguments as to be made why you shouldn’t contribute to a Roth IRA.
Disadvantages Of The Roth IRA
Here are all the disadvantages of the Roth IRA. For those of you who are in the higher federal income tax bracket, you should be especially wary of contributing to a Roth IRA. For 2023, the maximum Roth IRA contribution, if you are eligible, is $6,500.
1) 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? No. How about giving a drug addict some meth? No. Would you eat a double cheeseburger in front of an obese person who is trying to lose weight? Of course not! There is a reason why there are $2,000 staplers and $10 staples in the government budget.
There’s a reason why there is at least $64 Billion in fudged Army accounting every year. Why do you think the Social Security system is underfunded by ~25% and will remain underfunded forever? The government wastes your money, so don’t give it more.
Due to the global pandemic, the Federal Government is unleashing trillions of stimulus money to help support the economy. As a result, the government will eventually come for you.
2) The government is smarter than you.
The government realizes people are bad with their money. This is why it sets 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!
3) You allow asymmetric reward or punishment between equals.
Not everybody can participate in a Roth IRA. Only those fortunate enough to make less than $153,000 a year as an individual or less than $228,000 for married couples can contribute the full Roth IRA amount . After making more than $153,000 a year for singles and $228,000 for married couples, you cannot contribute to a Roth IRA. 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. If constant protests have taught us anything, it’s that 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 the Roth IRA maximum income limit for contributing from paying more taxes and getting tricked into entering the Borg.
Unfortunately, there are income limits for maximum contribution to get a tax deduction for a traditional IRA as well. They are an even more egregious at $83,000 for single filers and $136,000 for married filers. Talk about a low income level cap to contribute to a traditional IRA.
4) 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 $400 million dollars if you had contributed the money to a 401(k) or IRA instead.
However, don’t forget about the opportunity cost of the $2,000 that would have also grown as well had you not paid $2,000 in taxes up front. The $2,000 would have grown to around $400 million.
5) What will $6,500 do for your retirement?
A max contribution of $6,500 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 $22,500 for 2023), and you are eligible for a Roth IRA maximum contribution for a single filer ($153,000 income or less), you probably will get more out of spending your $6,500 on life now.
I am a big proponent of aggressive savings. However, if you are earning up to ~$130,500 a year in gross income after maxing out the 401(k), I’d rather you not tie up that $6,500 in a government savings vehicle until 59.5.
Invest your money in a low cost investment account like Personal Capital, the leading digital hybrid wealth advisor today. Or keep your cash liquid, especially now that interest rates are rising.
6) You may never reap the fake rewards.
Let’s say the math wasn’t the same. 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.
Speaking of losing out on all the contributions, make sure you get married before you die before hitting the age of Social Security collection. If you end up paying FICA tax for 40 years and then die single, the government gets all your Social Security benefits! Again, the government is smarter than you.
7) 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.
Related: The Ideal Age To Withdraw From Social Security
8) 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%-13.3% and we’ve got a huge budget deficit, especially due to 4+ months of economic lockdowns! 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.
See: States With No Estate Taxes and The Best States To Buy Real Estate
Choose The Traditional IRA And Max Out The 401(k)
Hopefully you now recognize all the disadvantages of a Roth IRA.
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 ~$153,000).
Your tax rate is low. You might as well save and make a bet that you will make more money as you gain more experience. However, even though you are in the lower tax bracket and assume to make more, make sure you at least max out your 401(k) first.
For those of you in a higher marginal income tax bracket, doing a backdoor Roth IRA conversion could very well be a waste of time.
Always Do The Math Before Contributing To A Roth IRA
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. This equals an effective tax rate of 12.5%.
However, you are squarely in the 22% federal tax bracket. Therefore, the $6,500 you are contributing to a Roth IRA is paying a 22% federal tax rate, not your effective tax rate of 12.5%. 22% is OK, but don’t forget state taxes.
Let’s say you are hot stuff now and make $129,000. $129,000 is the very income edge of where you can still contribute to a ROTH IRA as a single in 2022. Your Federal Tax bill is now around $21,000, or an effective tax rate of 17%. However, your $6,500 maximum Roth IRA contribution is paying a 24% federal tax rate.
You’re not really saving 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 $144,000. Over $144,000 you start to get phased out.
The $153,000 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, therefore, taxes will unlikely ever go up for this income group! In fact, Biden has promised he won’t raise taxes for any household making under $400,000. Not bad.
Final Disadvantage Of A Roth IRA
You will unlikely make more in retirement than while you are working. As a result, you will likely be in a lower income tax bracket in retirement. Let’s crunch the numbers.
Let’s say you make $153,000 a year or less for your entire life. As a result, you are able to contribute to a Roth IRA. Do you really think when you retire, your income will now be more than $153,000 a year? Only if you earn $153,000 or greater are you in the same tax bracket.
Be realistic. At today’s 10-year risk free rate of 3.5%, you need $4.371 million dollars to generate $153,000 a year in income! And that’s before taxes! OK, let’s say you can generate a more realistic 4% annual rate of return. To generate $153,000 gross a year in retirement income would require capital of $3,825,000.
$3,825,000 is a more achievable amount of investment capital to accumulate in retirement. But if you look at the data, the average net worth in America is closer to $500,000. And worse, the median net worth in America is below $70,000 according to the latest global millionaires report.
Therefore, you will likely NOT make more in retirement than during your working years. Stop being delusional! Even if you received the average Social Security benefit of around $21,000 a year, you will likely not make more in retirement than while working.
If you have not maxed out your 401k, please do so before even considering contributing to a Roth IRA.
The Bloated Government
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 you. You have the power to make a good living. Don’t be fooled by the government who want to make money off of you. The more money you make, the more you’ve got to get into the tax savings mindset. There are people out there who actually pay a higher percentage of their income in taxes than they save. Shocking.
Fight on and open your mind.
Thanks to all the wonderful feedback over the years, I’ve been less dogmatic about the disadvantages of the Roth IRA. If you have children, opening up a Roth IRA for your children is a no-brainer. They can earn tax-free income up to the standard deduction limit. Then they can contribute $6,500 of the income into a Roth IRA to earn tax-free returns. Finally, they can withdraw the money tax-free.
People should diversify their retirement savings for tax reasons. However, be aware of higher taxes under the new administration.
Related Posts:
The Only Reasons To Contribute To A Roth IRA
Why I Never Contributed To A Roth IRA By Why You Probably Should
Opening Up A Roth IRA For Your Kids Makes Sense
Build Wealth Through Real Estate
In addition to investing in stocks and bonds through your Roth IRA, I recommend diversifying into real estate as well. Real estate is a core asset class that has proven to build long-term wealth for Americans. Real estate is a tangible asset that provides utility and a steady stream of income if you own rental properties.
Given interest rates have come way down, the value of rental income has gone way up. The reason why is because it now takes a lot more capital to generate the same amount of risk-adjusted income. Yet, real estate prices have not reflected this reality yet, hence the opportunity.
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Disadvantages Of A Roth IRA is a Financial Samurai original post. I’ve been helping people achieve financial freedom sooner, rather than later since 2009. Join 60,000+ others and subscribe to my posts or free newsletter for more financial goodness.
I have to disagree on thinking a Roth IRA is not tax efficient. I use my Roth for aggressive stocks & mutual funds, while my regular IRA has less aggressive stocks/mutual funds.
In my situation, I started contributing to a 401K Roth in 2007 when my company first introduced it. The company match was always put into the regular 401K by default. 10 years later, I was luckily able to retire early at 50 yrs old. I ended up contributing overall $146K to my 401K Roth, and calculated that I paid an additional $36K in upfront taxes based on my yearly tax bracket (generally the 25% bracket). Now it’s 2021, and the $146K in my Roth has grown to $567K and I’m 54 years old.
Since I can’t touch my money until 59.5 years, let’s assume I wait 7 more years and that $567K will be worth about $1.1M (assuming the rule of 72) – all tax free. Now with the Roth money, I can artificially keep my AGI in the lowest tax bracket (10%) until Social Security & RMDs kicks in at 70\72 years.
If I had only contributed to a regular 401K, now that $1.1M is taxed at a minimum of 10% – which means that is $110K in federal taxes, plus probably another 10% in state taxes. So that comes out to $220K in taxes I would pay with a regular 401K. With my Roth IRA, I paid $36K in taxes upfront.
The only way a regular IRA would have been better is if the lowest tax bracket drops below 3% – which will never happen.
Sounds good. I hope your Roth IRA does double in 7 years. Although that seems aggressive unless you are 100% in equities and our bull market lasts that long.
Don’t forget to calculate what the $36,000 in upfront taxes could have grown to as well.
I think the Roth IRA is a good way to diversify your retirement income, but only if you are in a lower tax bracket.
“5) What will $6,000 do for your retirement?
A max contribution of $6,000 a year isn’t going to get you to the promised land.”
$6000 per year invested for 40 years at 10% will net you 3 Million. That’s nothing to sneeze at.
Personally, I am dividing retirement dollars between Roth and my simple IRA plan at work.
I make 70K and contribute 3% to the simple which is matched by my employer for a total of $4200. I then max out Roth IRA’s for my wife and myself for another $12,000. That’s about 23% of my gross income.
We have 280k combined in our Roths and 135k in pretax IRAS. Having both types of accounts allows me to diversify between stocks and bonds with the more aggresive investments in the Roth and the more conservative in the Traditional. This should help to lessen my tax burden later on.
Additionally, If the tax structure remains relatively similar, having both types of accounts to pull from will actually allow me to withdraw a significant amount of my Traditional tax free due to standard deductions. For instance in the current tax year If a couple filing jointly needs 100k, they can receive 35K from Social Security, withdraw 21k from a traditional IRA and 44K from a Roth IRA and they would owe no taxes. If the same couple took 35K from Social Security and 65K from a traditional They would owe about $8k in taxes.
Yeah I fell for the Gov’s whole propaganda about stressing the importance of establishing an IRA for retirement. But as I dug deeper there’s really no reason to do it in the first place. It’s my money and I should be able to access my investment portfolio’s as I see fit! Why the hell is the Gov even saying oh it’s in your best interest to save until you’re 59 ½. Otherwise be prepared to face a tax penalty. Like wth, what is up with this bs?
Life happens and I should be able to sell some positions and withdraw from my retirement portfolio as I see fit. To hell with still getting the same taxes taken out on top of an additional 10%. I also read somewhere that it’s 25% if you have an IRA for less than 2yrs and decide to close it!
Im already using two brokers for personal stocks and crypto. Atleast with these they have the exact same growth opportunities as an IRA would if you had the same positions in the IRA like you did with your personal portfolio. I basically treat my personal portfolio as my own personal IRA. It’s an investment for a reason. I’m not delusional in the least bit, I’m not day trading unless I see a stock has a chance to gain some substancial gains. Otherwise I’m already investing for the long term. No matter how you look at it in this case, an IRA just has way too many drawbacks. Plus I don’t like the fact that the Gov dictates that I’m a bad investor for withdrawing early, so now I have to pay an additional 10% tax on top of what I’m already getting taxed. Well to hell with that.
So now I’m facing this exact conundrum. I started using Stash strictly for ETF’s. They just seemed to have a better platform for long term investments with etfs, bonds, reits, etc. They created some of their own etfs for you to choose from. I like their stock back reward program. Plus I use it as my bank account, but namely as a sort of secondary savings account. I was planning to set aside 20% of my income to my main savings, 15% to my personal portfolio, 15% to stash as a secondary savings and for ETF’s. I may switch it around here and there. But essentially I am wanting to deposit $500 a month in Stash so I would get a decent amount in compounding interest rates at a 5% annual growth rate.
So when I first created my stash they automatically put my in the highest subscription which was only $9 and had all.the bells and whistles. Well they took it upon themselves to start me an IRA. Well I caught it or so I thought and switched to the basic subscription that’s only $1 per month. Well unbeknownst to me it set it on the mid their subscription that’s only $3 a month. But they deposited $45 towards the IRA! I’m not sure how the hell this even happened to be honest. I had already deposited $400 in the personal portfolio for my etfs. I was planning to slowly sell of my stocks from my other portfolio’s in Robinhood, etc. I figured this could take awhile as I already have a substantial amount in my positions with my other brokers. I’m in no hurry but was looking forward in using Stash.
Anyways I’m not sure how they just automatically deposited $45 in an IRA? Apparently I was set up for $45 per week reoccurring deposits. I stopped it immediately when I found out. Fortunately it only chosen 1 etf which I already own in my other portfolio. So it only made a 2 cent gain. But now I have to go through the headache of having to sell the positions in the IRA and close everything out.
I’m glad I caught it early and this was because I was alerted when they withdrew the $45 from my bank account. I did hesitate for awhile and thought to myself wth maybe I should have an IRA. But then logic dawned on me and I said hell no! I do not like the fact that I have to wait a quarter of a century until the Gov deems me worthy enough to touch my money. Plus If I would of been indecisive and waited too long I’d just get penalized even more. So better to stop it immediately and just pay the damn 10% on the $45.02 that’s in the IRA right now.
I’m liking Stash so far besides this whole fiasco. But I’m willing to leave it up to this being a mistake of my own doing. I may of did this unknowingly while I was getting familiar with the app. It is what it is, it’s just bs now that they are going to tax me on my own money. Income that has already been pretaxed that alone is enough for anyone to be alarmed about getting an IRA. So if anyone is up in the air about getting an IRA don’t!
Just get you a pretty decent diversified portfolio. Make sure to get you a few stocks you believe in, some etfs, bonds and maybe a few reits even. Either way if you ever want to sell your positions for any reason. You can do so without worrying about getting penalized. Be smart with your money, most of don’t be giving it away to the Gov by getting taxed upon being taxed!
Hey, I am 74 and saved most of my retirement funds in my 401K at work. I am pretty financially savvy, but really struck out on how much appreciation my investments had, so now I actually have a higher income than I had working and am still stuck paying taxes at levels ABOVE what I did when I worked. I think the 401K is a TAX TRAP. I agree wholeheartedly w/you that our government deserves NOTHING. It is hell trying to figure out how to pay fewer taxes. I live in Illinois like one of your commenters, and I have been considering what he says he will do, but if you are not careful you will jack your Medicare premium up and never get it down. I help all my kids and their significant others invest and I am having them utilize the 401 K, but ONLY to their company’s match and then MAX the measly $6 K in their Roth. But if I only had had my Apple stock (from 1999) in my Roth instead of my 401K life would be good. Maybe my kids will turn their Tesla into a windfall of sorts. If we didn’t have such corrupt unions and politicians things would be better. Good luck to everyone!
Roth IRA Kick in the Gut
I haven’t seen anyone mention the fact that if you are not rich enough to pay for years and years in a nursing home for yourself, to the tune of probably $200k/year in a decade’s time, out of your assets, then you will go on Medicaid. Double that if you have a spouse that needs assistance too. How many years of spending $400k can you afford?
Medicaid rules vary by state and most states considered IRAs “countable” (things that you have to spend down before going on Medicaid, even if it is your spouse’s IRA). However, currently there are some states that do not consider IRAs as “countable” if they are in payout (RMD) status. I can’t post links, so you’ll have to search for this info yourself. Currently only three states don’t consider you and your spouse’s IRA as countable even if they are not in payout/RMD status.
So here is the kick in the gut – you and your spouse’s Roth IRAs are NEVER in payout/RMD status and therefore (in most states) ARE countable assets that you have to spend before you can go on Medicaid. So a good chunk or all of your years of contributing to Roths and filling your tax brackets by back dooring into Roths will be for naught if you are forced to spend it on assisted living or skilled nursing care – which ~70% of us will for some length of time. Remind me again which states allow assisted suicide?
This is definitely a concern, but this is easily fixed. Regardless of your state’s rules, you can keep a $600 S&W .357 Magnum around in case you deteriorate to the level of needing nursing home care. POOF! You’ll still leave behind an inheritance for your heirs and save yourself years of suffering.
Not a good idea to say things like this in a world where a fair chunk of people can be clinically depressed. It would be a service if you would delete your comment, which might just move some marginal soul to make a very bad “momentary” decision.