Are Roth IRAs really that good?
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Let’s talk Roth IRAs. Every personal finance influencer in the world talks about how awesome Roth IRAs are, but are they really that great? I understand that earnings in a Roth IRA are not taxed if they are withdrew after age 59. But should I really be saving money for when I am 60 years old? In a sense, I feel like I would rather spend that money while I am young and can be more adventurous.
I am not completely out on Roth IRAs, I just think they are over-hyped.
What do you think? I would love to be convinced otherwise.
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@mike_imm_ubund said in Are Roth IRAs really that good?:
In a sense, I feel like I would rather spend that money while I am young and can be more adventurous.
You can spend all you want, but don’t come crying when the kids put you into a nursing home when you’re old and COVID 2060 comes and gets you.
You can only put so much money into an IRA, and it’s compounding, so you should start as early as you can. You will regret it when you’re older.
As far as Roth vs regular, I prefer Roth, but I could be convinced either way. At some income level you are not able to get the tax benefits of regular IRA and backdoor Roth rollover is your only option.
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Are you trying to spark conversation by being controversial? Did your parents not give you financial education? Not saving for your future because you want to have fun now? Seriously? You can’t regain the time lost. I presume you’ve seen the graphs showing the importance of investing over time.
Are you talking about Roth IRA vs. other forms of saving towards retirement? Traditional IRA’s the money was put away pre tax but then you paid the tax when you withdrew it. In theory your tax rate after 65 is lower BUT with a Roth there’s no tax after 59. So Roth > traditional IRA.
I had a lot of fun when I was younger and I continue to have fun but starting when I was 27 yrs old I started putting $2500 a year in a traditional IRA. Back then that’s all I could contribute. Roth didn’t exist. Limits have probably changed. 25 years later my initial $2500 was $30K. Looking back would I rather have had another $2500 in fun or would I rather have $30K today? Its a no brainer.
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@my4mainecoons said in Are Roth IRAs really that good?:
Are you talking about Roth IRA vs. other forms of saving towards retirement? Traditional IRA’s the money was put away pre tax but then you paid the tax when you withdrew it. In theory your tax rate after 65 is lower BUT with a Roth there’s no tax after 59. So Roth > traditional IRA.
Well with traditional Roth you pay tax now, with traditional you pay it later. Once you are not eligible to save tax on traditional, Roth becomes a no brainer, but I’m not sure I’ve decided one way or the other on my preference if I am able to contribute to regular IRA.
Also if you have an HSA it basically becomes like an extra traditional IRA I believe.
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1 Reply
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@dangeruss I had traditional IRA’s because when I started that’s all that there was. Then I went back to school. Had no income while a student so I converted all my traditional IRA’s to Roth because my tax bracket was so low. I won’t be paying anything on the Roths when I start withdrawing.
One year my income was too high to qualify for a Roth so instead I contributed to a traditional IRA. My interpretation of that was that Roth was preferable. I’ll have to pay tax on it when I withdraw it when legally it has to be withdrawn (69-1/2?)
I have a HSA from a previous employer and there’s money in it but you can’t add to it, you can only spend and AFAIK there’s no age minimum for spending it. I’ve only used a little when I’ve maxed out Flexible Spending for the year so tax liability has been low.
I max out a 401k, 457 and Roth each year.
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@my4mainecoons I appreciate the response…and I am just looking for insight. I agree that at a young age a Roth IRA is preferable to a traditional IRA in most settings (lower tax bracket: makes sense to be taxed upfront). I am thinking of a scenario where you are a college/ just post college student with likely a small income and a large sum of student loans or other fees to pay off. As a diligent budgeter, you forecast your expenses and want to allocate a portion of your remaining savings to both investing and an emergency fund. In this scenario, would it make more sense to passively invest in the market traditionally rather than invest through a Roth IRA? That way if you need liquidity, you are only taxed on your earnings, rather than a Roth pretax and an early withdrawal fee on earnings?
I know it seems specific, but this a scenario popular to college students with low incomes. Even if you did have a separate emergency fund and Roth account, your contributions to Roth may be so small that they would be insignificant (relative to your net worth at retirement), and it may be worth using the cash as disposable income now.
Also, no… my parents did not give me the “Personal Finance Talk”. I do not think it is as popular as the other “talk” parents have with their children
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@my4mainecoons said in Are Roth IRAs really that good?:
One year my income was too high to qualify for a Roth so instead I contributed to a traditional IRA. My interpretation of that was that Roth was preferable. I’ll have to pay tax on it when I withdraw it when legally it has to be withdrawn (69-1/2?)
You should be able to do a backdoor Roth (rollover a traditional to a Roth) even if you don’t qualify for a Roth (or a traditional). You will have to pay any taxes you may have saved when you originally contributed to the traditional.
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Pay now or pay later in either case as long as you’re alive you’ll have to pay taxes. If you’re dead, your heirs would pay the taxes eventually when the funds are withdrawn. However, not if it was in a Roth IRA account and you’ve had it open for at least 5 years.
I’m in favor of the Roth, but it makes sense for people in the higher tax brackets (32%+) or living in high tax areas to see if it makes sense for their specific circumstances. I think of having the Roth as a hedge or a diversification. While I believe I might be in a higher tax bracket when I retire based on my projections and because I am a “financial mutant”, you never know. What I do know is the current tax rates are set to expire after 2025 and will revert to the prior rates so forget about retirement, I know taxes rates are definitely lower now, at least for me it is.
You can always withdraw your contributions from a Roth IRA account without penalty, it’s just the earnings that are taxable prior to having the account at least 5 years and if you are not older than 59 ½ years old. In your scenario of a college student, if your income is low, you’re probably in one of the lower or lowest tax brackets already so how much are you saving pre-tax? If you’re doing after-tax you’re not being taxed much anyways so the Roth is a no brainer for either the young or people in lower incomes currently who will eventually make more as they reach their prime earning years.
Investment accounts, Roth IRA, or emergency fund. Who says that you have to choose one? If you can, do all three, just in different percentages. If not, set up the emergency fund first, then Roth to start the 5 year count, and then the brokerage.
Most people never think about retirement until they are older. Then one day they wake up and panic. There will always be excuses: 20s you want to enjoy life and can’t even think about retirement 40+ years away, 30s you have a family and then expenses start piling up, 40s you’re have the kids’ college expenses, 50s maybe mid-life crises or you’re the sandwich generation and have to take care of your parents, 60s health goes downhill so it’s medical expenses. You’re already ahead of the game if you’re reading financial blogs/websites. Just start, do a little, and set it on autopilot.
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Roth IRA are overvalued… if you make a lot of money.
A general rule of thumb is to look at what your tax rate is today vs. what you expect it to be in retirement. If your rate in retirement is expected to be higher, put your money in a Roth. If your tax rate today is higher, take the traditional IRA deduction.
Made complex by absolute uncertainty around future tax rates, but my kids all put their retirement monies in Roth since they have an effective 0% federal tax rate. By contrast, if you are in the 31%+ federal tax bracket, you may want to put your money in a traditional IRA. Or maybe not - perhaps you’ll be even more flush in retirement.
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Say you’re in a high enough tax bracket now that you prefer Traditional IRA. When you retire, do iso at the beginning of the year so you have little income that year. Convert your IRA to a Roth; possibly just some of it to stay in a lower bracket than when you contributed. You may also want to delay filing for Social Security that year (unless you’re age 70).
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The traditional tax deferral model made more sense when marginal tax rates were higher --> federal rates were 33% for $35,200 and 42% for $60,000 of taxable income in 1984. You can roughly multiply these by 2.5 to get them into todays dollars ($88k and $150k, respectively). The idea was you’d see a lower tax rate in retirement than during your working years, which was the case when far more people were paying taxes.
Now, the number of brackets are reduced, and the rates are lower on most people. Current marginal rates are 22% up to $168k (all figures are married, filing jointly, but it’s a similar story for the other filing statuses).
Aside from the question as to whether you will have higher tax rates when you retire, Roth accounts have another VERY valuable benefit – by having lower taxable income in retirement, you may not surpass the point where Social Security is taxable to you (or less of your Social Security benefit may be taxable when you receive it).
A few years ago, there was a proposal in Congress to require all future IRA/401(k) contributions to be of the Roth variety. This was clearly a budget balancing initiative, since Congress would effectively raise tax revenue. Retirement “tax breaks” were cited as the #3 tax “expenditure” according to the government, following healthcare and mortgage interest deductions (the latter maybe falling in rank post-tax reform) – these other two are sacred cows to most Americans (i.e., the voting public), so removing those benefits would have caused an outcry.
I looked at a few different income levels back then, and I was surprised to find that for most people, Roth wasn’t really detrimental. Actually, it was beneficial on a few different fronts:
- the Social Security Benefit tax issue discussed above (mostly applicable to lower-middle income people),
- It allows people of all income levels to save more (in value). $6,000 (IRA) / $19,500 (401(k)) post-tax with interest is worth far more at retirement than the same amount pre-tax. Yes, I realize you need to contribute more (e.g., if you are in a 22% tax bracket, you’d be contributing the equivalent of $7,692 or $25,000 on a pre-tax basis for the IRA and 401(k) limits, respectively. But you’d have that same higher multiple of retirement value down the line, unless you think your taxes will be lower in retirement (either due to your retirement income or due to overall changes in tax policy)
- For the people who already max out their retirement savings (contribute the $6,000 or $19,500) and invest/save other money for retirement in taxable accounts, Roth is a “no brainer”. You are already investing after-tax dollars, but the income on those is fully taxable. So a high earner in the 24% tax bracket (or higher), you can contribute these amounts post-tax and will never be taxed on them again (assuming you meet the Roth withdrawal rules).
Personally, a mix of traditional and Roth makes the most sense to me. You’d have some taxable income in retirement (and save some taxes today), but you’d also have some non-taxable income in retirement (which could have other benefits like reducing the portion of Social Security Benefits that are taxable)…
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She. I was younger I used my Roth as an emergency fund. I started it at 18, so at 23 I was able to take the initial funds out without tax.
If you have kids, get them to open an IRA when they turn 18 for added financial flexibility.
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I got lil miserlys to contribute to Roth as soon as they had income. Yes, much better rta that age to be able to compound o er longer time horizon. I have a mix. Wish I had more in Roth as I wouldn’t havt to pay for gains over the last few years.
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one issue is future congress could still excise tax or other BS on “excess”
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@miserly said in Are Roth IRAs really that good?:
I got lil miserlys to contribute to Roth as soon as they had income. Yes, much better rta that age to be able to compound o er longer time horizon. I have a mix. Wish I had more in Roth as I wouldn’t havt to pay for gains over the last few years.
Now that the market is down a bit you can rollover to Roth. Although I think it goes by cost basis anyway. Either way I think if you have both Roth and regular you should roll everything over to Roth as it can be tricky on your taxes when you have a mix.
