Workplace retirement accounts are the most popular option for retirement savings because they’re easily accessible, and employers contribute. Aside from this, the standard choice these days is a Roth IRA. The account has the following benefits:
• It’s easy to open with a brokerage or bank
• Withdrawals are free from tax
• The government can’t force withdrawals before you need them
Even after this, Roth IRAs can also be a more affordable option to a traditional 401(k). So, they’re the perfect option for retirement, right? Wrong, and we have three examples where Roth IRAs aren’t the best choice for retirement savings.
1. You Miss Company Match
Putting money into a Roth IRA brings all the benefits listed in the introduction, but these benefits are quickly outweighed if you’re missing out on potential matched contributions. As you probably know, these matched contributions are only available with a workplace retirement account.
If you could still enjoy this match, it might be better to wait before investing in a Roth IRA. There’s nothing wrong with lining an account up for the future but get the maximum company match first. Alternatively, your employer might offer a Roth 401(k), which can replace the Roth IRA. Essentially, you get the best of a Roth IRA and 401(k) with tax-deferred company matches and larger contribution limits.
Contribution limits are as follows in 2020:
• Roth IRA – $6,000 ($7,000 when over 50)
• 401(k) – $19,500 ($26,000 when over 50)
2. Your Earnings Are High
As we’ve just seen, Roth IRAs have income limits, and this is a problem for those with high earnings. Essentially, the limit on your account will depend on your AGI (adjusted gross income) with some tax deductions added in; this is referred to as MAGI (a modified version of AGI). If you want to contribute to the annual limit, the MAGI should be under $124,000 for individuals and $196,000 for married couples.
What if your MAGI is above this amount? Well, direct contributions may not be available, or you might be forced into reduced contributions. If you are intent on using a Roth IRA, you’ll probably rely on what’s called a ‘backdoor Roth IRA.’ After investing in a traditional IRA, the idea is to then partake in a Roth IRA conversion. Although more complicated, it’s a system that many use every year.
Even if you can’t directly contribute to a Roth IRA because of your earnings, the tax savings normally make a tax-deferred account worthwhile. Before making any decisions, weigh up the pros and cons, depending on your savings goals, earnings, and potential future earnings.
3. Your Tax Plan Doesn’t Reward a Roth IRA
How much do you think you will spend in retirement? When you consider this, it’s easier to make a decision regarding a retirement account. When you’re in a lower tax bracket, it’s possible to reduce the amount of money the government claims. For those in a higher tax bracket, the wrong account will have you paying lots of tax now when you could have waited and paid less with a tax-deferred account.
When deciding on a retirement account, it’s important to consider your financial position now compared to your financial position in retirement. As contributions reduce taxable income, they can bring you into a lower tax bracket. Although this means paying tax in retirement, income will reduce by this point, and the government gets less of your money.
Summary
Roth IRAs certainly have many benefits, but this doesn’t mean they are the best option for every retirement saver. A Roth IRA isn’t the perfect fit if your earnings are high, if your tax plan lends itself to a different retirement account, or if you’re missing out on matched contributions from your employer. If these aren’t an issue, it’s good to place money into a Roth IRA to spread risk and start saving towards retirement.
