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).
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 hands down 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.
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 .Would you give a drug addict some meth? No. Would you eat a double cheeseburger in front of an obese person who is trying to lose weight? No, no, no! There is a reason why there are $2,000 staplers and $10 staples in the government 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, which is why they set up a withholding tax system to make sure people pay throughout the year. If it was up to everybody to pay their year-end taxes at the end of the year, all hell would break loose because people are not disciplined to put money away to meet their obligations! The country would go into instant default.
As a result, the government has pushed propaganda on the masses to get them to pay MORE TAXES UPFRONT, hence the introduction of the Roth IRA. They will spend millions on marketing to highlight why converting to a Roth and participating in a Roth IRA is a great idea. Yes, it’s a great idea for them, not for you!
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 $144,000 a year as an individual or less than $$214,000 for married couples can contribute the full Roth IRA amount for 2022. After making more than $144,000 a year for singles and $214,000 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 the protests in 2020 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 a traditional IRA as well, which are even more egregious at $68,000 for single filers and $109,000 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 $6,000 do for your retirement?
A max contribution of $6,000 a year isn’t going to get you to the promised land. If you are already maxing out your 401K (pre-tax contribution up to $19,500 for 2021), and you are eligible for a Roth IRA maximum contribution for a single filer ($124,000 income or less), you probably will get more out of spending your $6,000 on life now.
I am a big proponent of aggressive savings. However, if you are only earning up to ~$100,000 a year in gross income after maxing out the 401K, I’d rather you not tie up that $6,000 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.
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 ~$125,000).
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 pre-tax traditional IRA first.
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 $6,000 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 $6,000 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 $129,000. Over $129,000 you start to get phased out. You can’t contribute completely after $140,000 for 2021.
The $129,000 and below income level for single filers is the protected middle class where no politician dare assaults. The middle class is what puts politicians in office and therefore, taxes will unlikely ever go up for this income group!
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 $145,000+ 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 $145,000+ a year, putting you in a higher income tax bracket?
Be realistic. At today’s 10-year risk free rate of ~1.8%, you need $8+ million dollars to generate $145,000 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 $145,000 a year in retirement income would require capital of $3,625,000.
$3,625,000 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 $50,000 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 $15,000 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.
Don’t Feed A Poorly Run Government
When I first wrote this post, it was during the Obama adminstration era when taxes were higher.
Then Donald Trump became president. He signed the Tax Cuts and Jobs Act in 2017 that lowered federal income taxes, corporate income taxes, and raised the estate exemption amounts in 2018 and beyond. The law does not end until 2025.
In other words, if you were contributing to a Roth IRA before the Trump era, you paid more in taxes than you need to. This was a huge disadvantage of a Roth IRA. Now you’ve just got to accept this reality and move forward. In 2021+, it’s relatively better to contribute to the Roth IRA today given the lower marginal tax rates.
The previous government thanks you for paying more taxes up front out. They thank you for your belief that you will earn more money in retirement than while working. Now, tax rates are likely going up.
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. People should diversify their retirement savings for tax reasons. However, be aware of higher taxes under the new administration.
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.
My favorite way to invest in real estate is through real estate crowdfunding. My two favorite two real estate crowdfunding platforms are:
Fundrise: A way for accredited and non-accredited investors to diversify into real estate through private eFunds. Fundrise has been around since 2012 and has consistently generated steady returns, no matter what the stock market is doing. For most people, investing in a diversified real estate fund is the best way to go.
CrowdStreet: A way for accredited investors to invest in individual real estate opportunities mostly in 18-hour cities. 18-hour cities are secondary cities with lower valuations, higher rental yields, and potentially higher growth due to job growth and demographic trends. If you have a lot of capital behind, you can build your own select real estate fund with crowdStreet.
Both platforms are free to sign up and explore.
I’ve personally invested $810,000 in real estate crowdfunding across 18 projects to take advantage of lower valuations in the heartland of America. My real estate investments account for roughly 50% of my current passive income of ~$300,000 so we can live free.
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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. Subscribe to my posts or free newsletter for more financial goodness.