Everyone should be saving into a Roth IRA for retirement!
Have you heard those words before?
I’ve seen them strewn about the web here ‘n there on various blogs or in comments on other personal finance sites.
Is that true? – Should everyone be saving into a Roth IRA?
Not exactly.
Although Roth IRA’s have become a very popular retirement account over the last 10 years, and have contributed greatly to the whole “Tax Diversification” conversation, there are still some scenarios where they don’t make sense.
Let’s take a look at three reasons why you should NOT use a Roth IRA for retirement savings.
You Make Too Much Money
We all wish we had this problem right? Uncle Sam doesn’t want you to put money away that will be completely tax free if you are a high-income earner. They will actually phase you out of your contributions beginning at a certain income.
What exactly is a high-income earner?
Well, here is the breakdown for Roth retirement savings:
If you are a single filer and you earn between $105,000 and $120,000 you start getting phased out. Anything above $120,000 you cannot contribute to a Roth IRA.
If you are married filing jointly and make between $167,000 and $177,000 you get phased out. Anything above $177,000 you cannot contribute to a Roth!
So, here’s how this would apply – let’s say you are married and you’re knocking down$165,000 and you think your income is going up – do you really want to open a Roth IRA for possibly one year and then get phased out? Probably not, but at the very least you want to double check your figures and do what’s best for you.
So, if you make too much money – a Roth IRA may not make sense for you – or may not even be allowed.
Your Tax Bracket Will Be Lower in Retirement
Tax rates are at an all time low! What are the odds they’ll be going up soon? I’d say good to very good!
That being said, we generally don’t know for sure what tax rates will be when we retire.
Most folks do assume their brackets will be lower – and for good reason. If you’re making decent money through your peak earning years and expect your income to decrease drastically in retirement then there is a good chance you’ll have a lower bracket.
The reason you may not want to contribute to a Roth IRA in this case is because Roth IRAs use after-tax money for contributions. That means you’ve already paid the tax on it (in a higher bracket mind you) and will be pulling it out in a lower tax bracket.
The tax savings would not be legitimized if you are in a higher bracket now and a lower one later.
The difficult part is that we don’t know for sure what our brackets will be and also most folks want to maintain standard of living and might need the same amount of income in retirement, which means you need to carefully consider some numbers and figure out what the best route would be for you.
You Are Already Maxing Out a Traditional IRA for Retirement Savings
Let’s say that for whatever reason (you don’t have a 401k through work or you are using a Non-deductible IRA and then converting to a Roth) you are contributing to a Traditional IRA and are thinking about starting a Roth IRA – you need to be aware of the IRA contributions limits.
In other words, Uncle Sam only allows you to contribute a certain amount to all IRA’s no matter what kind.
So, if you are under 50 years of age, you can contribute up to $5,000 per year into an IRA. If you are over 50 – you can contribute up to $6,000.
If you are contributing the full $5,000 to a Traditional IRA, you cannot contribute another $5,000 to a Roth. It’s only $5,000 total!
So, where a Roth IRA would not make sense is if you really need the Traditional IRA to help lower your taxable income now rather than caring so much about tax-free down the road.
In that case you may want to max fund your Traditional IRA to reap tax benefits now.
If you are not max funding your Traditional IRA, you could split the difference (i.e. $2,500 to a Traditional and $2,500 to a Roth), but only if it makes sense for you from a tax standpoint after running some numbers.
What Are Your Thoughts?
Good things to think about concerning a Roth. But in looking at the possible lower tax bracket at retirement we should also bear in mind that the growth of the Roth is also tax advantaged. If I am correct the tax free growth would possibly (probably) outweigh the lower tax bracket issue.
Thanks
Number 2 is a very interesting concept and something that should be considered.
I had always thought it was a no-brainer till now!
Jason, great tips here. I think you’ve highlighted some things that will be helpful for people in making a Roth IRA contribution decision. If someone has limited investment options with their 401K, a Roth or Traditional IRA is a good option beyond any employer matching. Personally, I’d like to think my tax bracket will be lower and expenses too but it’s such a hard thing to determine. I would almost think about putting this consideration aside unless I was within 5-10 years of retirement and new better what things were going to look like then.
Jason, that’s a good point. Being 30 years away from retirement, it’s hard to know where tax rates will be. My guess is they’ll be much, much higher, but who knows for sure. I am still a huge believer in tax diversification, which the Roth provides.