Let me share why I never contributed to a Roth IRA, but why you probably should. I fully admit that I was once an ardent opponent of the Roth IRA in the past. But as a middle-aged father of two young children, I’ve come around. Contributing to a Roth IRA is a great way to diversify your retirement income sources.
If I could rewind time to when I was a junior in college, I should have opened up a Roth IRA and started investing. Don’t make my same mistake. Time is the most powerful asset when it comes to investing.
Roth IRA Wisdom From My Father
My dad is in his 70s and he mentioned he wish he’d started a Roth IRA when he was young. When you’re in your 70s, you must take required minimum distributions (RMD) from your pre-tax retirement savings accounts and pay taxes.
Given nobody likes to pay taxes, I empathized with his regret. It’s also a good idea to listen to your elders.
With the passage of the Secure Act 2.0, the RMD age increases to age 73 in 2023 and to age 75 in 2033.
But I don’t have a problem paying taxes on income earned. It’s only when I have to pay a surprise tax where the liability wasn’t properly budgeted where I have a problem. This only happened to me once when the state of California passed a retroactive tax of 2.9% for the 2011 tax year.
Now that I’m older and wiser, let me share some of my excuses and encourage you to contribute to a Roth IRA if you are eligible.
Why I Never Contributed To A Roth IRA
1) I didn’t have much money left over.
When I first got a job in 1999, I was only making a $40,000 base salary living in Manhattan. $40,000 did not feel like a lot of money back then, especially since I couldn’t even rent a one bedroom apartment on my own. Even splitting a studio apartment for $1,800 total required my brother-in-law to be a lease co-signer. In NYC, you needed to make at least 40X the monthly rent in annual salary, and my roommate and I did not make over $72,000 combined.
After maxing out my 401(k) to the tune of $10,500 and paying taxes, I didn’t have much left. I needed the ~$200 month left in cash flow to pay for incidentals. Something always tends to come up – like actually having some fun once in a while.
2) I didn’t know any better about the Roth IRA.
Ignorance is a common excuse for why we didn’t do things. However, it is up to use to get smart for our own good. The Roth IRA was introduced in 1997, when I was a junior in college. Saving for retirement was the last thing on my mind at that age. Getting a job was number one!
The 401(k) was easy to contribute to. It was automatically set up with my employer as part of my employee welcome package. All I had to do was fill out a form indicating how much should be deducted from my paycheck and year-end bonus, if any.
With a Roth IRA, I had to open up a new account. This felt like too much of a PITA at the time. When you are already not feeling rich, you don’t normally go out of your way to feel poorer.
Further, there wasn’t a ubiquity of affordable online brokerage options or personal finance blogs to provide any guidance.
3) The contribution limit was disappointingly low.
Even though I only made $40,000 my first year, being able to only contribute $2,000 maximum to a Roth IRA felt underwhelming. At age 22, I would much rather have $2,000 in cash than lock it up for at least five years. The poorer you are, the more valuable each liquid dollar is.
Check out the historical Roth IRA contribution limits. Only in 2019 has the Roth IRA contribution limit grown to a relatively significant amount of $6,000. The 401(k) max of $19,500 versus the Roth IRA contribution max of $6,000 ratio is now only 3.25X. Back in 1999, the ratio was 5.25X ($10,500 / $2,000). Therefore, focusing on the 401(k) was a better choice for me.
For 2023, the Roth IRA maximum contribution is $6,500. If you’re 50 or older, you can contribute $7,500 to your Roth IRA.
4) I hated paying taxes.
When you’re struggling to pay for a studio apartment with a friend while also working 70+ hours a week, the last thing you feel like doing is paying more taxes up front, which is what the tax-now Roth IRA retirement plan is.
My taxable income was $29,500, which put me at the 28% marginal federal income tax rate at the time ($26,250 – $63,550). Then, of course, I had to pay New York State and City taxes. It felt terrible paying 30% in taxes for a $2,000 Roth IRA contribution. So I didn’t.
The only way I’d feel good paying taxes up front for my Roth IRA contribution is if the effective tax rate was 15% or less. Further, I had to be working a leisurely 40 hours a week or less. Working very long hours makes you really bitter about the tax system.
5) I finally started making too much.
When I got my lucky break and moved to San Francisco for a new job, I was making a base salary of $85,000 and was guaranteed a $50,000 bonus. As a result, my total compensation in 2001 was about $120,000. This was $10,000 over the maximum $110,000 income allowed for an individual to contribute to a Roth IRA at the time.
Although it was nice to earn more money, it also felt disappointing to be shut out based on an arbitrary income limit. Why wasn’t the income limit $150,000 or $200,000? The government was implying not everybody deserves equal treatment.
In San Francisco, I still lived extremely frugally. I shared an even cheaper apartment ($1,600/month vs. $1,800/month in NYC) for the first two years. The $40,000 a year lifestyle stayed with me for another four years. I still wasn’t sure I’d be able to survive in the finance world for very long. It was only after I finished my MBA in 2006 did I start to spend a little more.
If you file taxes as a single person, your Modified Adjusted Gross Income (MAGI) must be under $140,000 for the tax year 2021 to contribute to a Roth IRA. If you’re married and file jointly, your MAGI must be under $206,000 for the tax year 2020 and 208,000 for the tax year.
6) I’d be in a lower tax bracket in retirement than while working.
This was the main reason why I thought contributing to a Roth IRA was illogical. Not only did I feel federal income tax rates would come down since 1999 (which proved correct after the TCJA was passed at the end of 2017), I also believed it would be incredibly hard to amass enough capital to reproduce my average W2 income wage.
For argument’s sake, let’s say I made $100,000 in 1999, meaning that I paid a 31% marginal federal income tax rate, or ~25% effective federal tax rate. My $100,000 turns to $75,000. I would need to accumulate $4,000,000 in capital producing a 2.5% gross yield to match my gross working income. I was bullish on my future, but not that bullish.
The people who are angry at my after-tax investment targets for early retirement, yet strongly believe in contributing to a Roth IRA are demonstrating inconsistent logic. If you don’t believe you can accumulate multiple millions, then you should not be contributing to a Roth IRA.
Further, I wanted the option to move to one of our no state income tax states in retirement. By contributing to a Roth IRA while working in one of the highest taxed cities in America felt like I was giving up.
Take Advantage Of The Roth IRA When You Can
After reading all my reasons on why I didn’t contribute to a Roth IRA, I hope you see them just as poor excuses.
Unlike me, be super bullish about your future.
I felt so burnt out after a couple years working post college that I thought I was just going to be a beach bum in Hawaii paying zero income taxes for the rest of my life. My grandfather had an old farmhouse I planned on staying in for free, in exchange for maintaining his mango trees.
Instead, I had a good 13-year career in finance. I got promoted to Vice President at age 27 and to Executive Director at age 30. After retiring in 2012, I ended up building Financial Samurai into an asset that generates significant supplemental retirement income.
Further, with the massive bull market that ensued in stocks, real estate, and bonds since I started working full-time in 1999, my passive income has also grown significantly. Therefore, I’m once again back at a high federal marginal income tax bracket, which I definitely did not anticipate in “retirement.”
The Roth IRA Is Retirement Income Diversification
I’ve warmed up to the Roth IRA because it is clearly a way to diversify your retirement savings and income. The maximum contribution has also increased to a not so insignificant $6,500 a year. Meanwhile, the income threshold for contributing has increased to $153,000 and $228,000 for single and joint filers for 2023.
$228,000 is a healthy income for married couples that put them in the top 15% of income earners. Even if you live in an expensive area like San Francisco or New York City, at least one partner should be able to max out their 401(k) and contribute the maximum to a Roth IRA.
Roth IRAs also have no RMDs; they can be assumed by a qualifying spouse upon the owner’s death and rolled directly into the survivor’s account (or a new account in the survivor’s name). They can also be transferred to a designated beneficiary tax free as well, under the same distribution rules as Traditional accounts: lump Sum or 5-year exhaustion.
Could Have Had $200,000+ In My Roth IRA By Now
If I was able to contribute $4,000 on average to a Roth IRA and earn a 9% compound return for 19 years, today I’d have about $200,000 I could withdraw tax-free. Over a 50 year period, my Roth IRA would grow to $3,553,000 with the same terms. That’s not something to sneeze at!
However, if you’re already in a higher tax bracket, then doing a Roth IRA conversion is probably not worth the effort. You likely won’t save tax dollars in retirement if you are above the 24% marginal income tax bracket.
Open A Roth IRA For Your Children
Unfortunately, I’m still not eligible to contribute to a Roth IRA. However, at least I’m able to open up a custodial Roth IRA for each of my two children.
They can earn up to the standard deduction tax-free, contribute to a Roth IRA tax-free, let their money grow tax-free, and withdraw tax-free! I won’t allow them to make the same mistake as their old man.
My hope is to put them to work for our family business. This way, they can earn income, save for retirement, and learn useful skills.
In 15+ years, I hope they will thank me!
Related: I Could Have Been A 401k Millionaire By 40 Had I Kept My Job
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Readers, who is contributing to a Roth IRA and how’s that going? Anybody contribute to a Roth IRA and make more than the income thresholds and have to stop? Is a backdoor or mega backdoor Roth IRA conversion worth it if you are in a high income tax bracket? Anybody now pay more in taxes as a retiree than as a full-time worker? If so, share us your secret to wealth.
Jeff C says
Suggestions for those married, filing jointly, maxing out 401k contributions (plus an LLC employer contribution) when income disqualifies you from taking advantage of a roth IRA?
Rob D. says
Sam, I belong to a special class of employee that I believe benefits greatly from Roth IRA contributions, vice Traditional. I am a Commissioned Officer in the Armed Services, and have three (3) categories of pay; Base Pay, a Housing Allowance (called BAH), and a Subsistence Allowance (called BAS). Only the Base Pay is taxable (Fed Tax, FICA-SS, FICA-MC), but the other two are not! Together, BAH and BAS equate to ~25% of my overall monthly pay. Our employee offered 401k retirement account (called the Thrift Savings Plan, or TSP) has both Traditional and Roth options (since 2014), so in essence, I can contribute the MAXIMUM amount permitted annually (2023: $22,500) directly into Roth. Additionally, we are able to have private/personal Roth IRA accounts, separate & apart from the govt retirement plan, and have consistently maxed those out since 2010! I am married filing jointly tax payer, and just far enough over the lower threshold of the 22% marginal tax bracket that would benefit from the tax deferred contributions. So I say feed the Roth Pig and let it ride!
Financial Samurai says
Love it! And for you, I agree. You’ll also enjoy this post on the best income to earn based on the latest tax rates.
I contributed to a ROTH before I had a 401k. It hasn’t grown that much since I focused on my 401k once I had access to one, but I’m still glad I opened one. Everything help when it comes to saving and investing for retirement!
I’m considering converting a small IRA (roughly $45k) to a Roth IRA. I was very curious to see Sam’s thoughts on this but saw he had several different posts on Roth’s (sometimes conflicting :)). Here are my reasons for converting at this point in time:
1.) Why now?: I’m 35 years old and work in sales in a very stable annuity like technology sector with uncapped income, and don’t expect my wife and my combined income to be lower than it is now anytime in the next 20 years. If Biden wins the election he has stated that he will be raising income tax on those who earn over $400k. So I see this year as the best time to convert.
2.) My IRA is small, my tax bill won’t be more than $20k for this one time conversion. Then beginning this year I will fund this Roth IRA via a back door contribution at a rate of $6,000 per year every year until I retire or decide to stop. Effectively funding a Roth while still being above the income limits.
3.) My wife and I both participate in traditional 401k’s which we max out every year. So this new Roth will essentially act as a hedge against our fully funded 401k’s and serve to give us more optionality on retirement spending as well as a more flexibility for inheritance strategy to our children.
4,) Sam asserts that we will all likely NOT earn more in retirement than we do now. However, he does not address the possibility that Marginal tax rates can be raised significantly in the future, so that even if say your retirement income is $150k in retirement, you could be paying a 45% rate on that income in the future like say almost half of Western Europe already does.
Sam and FS community, I’d really appreciate any thoughts and feedback on this strategy, feel free to rip it to shreds :)
FIRE DAD says
What are your thoughts about gifting $6k annually to son who then transfers that $6k to fund a Roth IRA in his name? He is in 20’s, a 1099 employee with about $50k income who does not have access to a 401k.
Goal of these annual gifts is to: have him start understanding investing (we will be discussing investments prior to purchase), let $ grow tax free over his life time, allow him access to some of “my $” before he inherits (age gap is 26 years), and reduce his tax burden/add flexibility on wd’s when he inherits my wealth. Note I may also be doing same with a $9k IRA to get to annual $15k gift max.
Assumptions: he is not going to raid the account for the wrong reasons, I am FIRE at 50 with net worth of $5MM/good cash flow – so $ is a small amount for me and fits in my annual expenses. Also he is sole beneficiary of wife/I’s $, and he has no other debt.
I have put lots of thought to this but alway looking to get more perspectives … thank you.
Best decision I made was to do Roth IRA.
Roth 401K converted to Roth IRA after retirement.
Roth conversions after early retirement when income was in lowest tax bracket.
Retirement funds currently 88% Roth, 12% Traditional
1. NO TAXES on distribution.
2. NO RMD
3. NO higher Premiums paid on Medicare.
4. NO TAXES on Social Security
There are many options to adding to Roth for any tax bracket.
Can you better explain your situation? How much did you made before you retired? How much are you pulling out each year for retirement? While you’re claiming that ROTH is better, I’d like to see the math behind it.
Jason Hilliard says
Sam – great post. Have preferred the 401k route for your same justification. Retirement income will be lower than our working years income by a long shot, so have been focused on growing after tax accounts, 401k, and real estate. The company 401k matching has been awesome kicker to that return and growth. Also have been maxing HSAs and doing 529s. Goal is to get kids through college debt free and then be in position to retire.