When is the Roth a Loser?

by Joe on April 9, 2012

Honolulu Aunty asks “Besides the limits of contributing based on income and the maximum direct contribution of $6000 per year (which can be overcome with different strategies), what do you see are the drawbacks or negatives of funding and maintaining a Roth IRA?”
Thanks for the question, your copy of Ed Slott’s The Retirement Savings Time Bomb is on its way.

Aunty, I think that just because something is good doesn’t mean that more is always better. Someone who manages to save only in Roth flavored accounts, whether the Roth 401(k) or Roth IRA, will possibly retire with no taxable retirement income. This has a certain appeal of course, who wouldn’t enjoy paying no taxes when they retire? There’s one downside to this. In 2012, a couple has combined exemptions and standard deduction totaling $19,500.

Let’s look at the big picture. Most people will be at a marginal 15% or 25% bracket. To keep the math simple, let’s call it an average 20% over time. They have a choice, to put say $500,000 over their lifetime (this includes market gains, of course) into a pre-tax account, and pay nearly zero tax upon withdrawal, or to pay the tax on that money as it’s earned and have $400,000 in the Roth at retirement. If we believe that 4% is the right withdrawal rate for a retiree, my pretax couple withdraws $20,000 per year and pays just $50 in tax this year as only $500 is taxable (remember, $19,500 in deductions.)  The Roth-only couple takes out just $16,000 per year.

It’s tough to predict years out let alone decades, but it’s possible to maintain a balance along the way. Those in the 15% bracket might want to save in a Roth, and shift to pretax as their income rises into the 25% bracket. A bit of attention each year to their tax situation should help them decide when and how to mix between pre and post tax accounts. It’s about balance.

{ 3 comments… read them below or add one }

Honolulu Aunty April 9, 2012 at 3:29 pm

Mahalo Joe, and I look forward to the book!!!

I can see why the Roth IRA would not be as advantageous in your example, but a $20,000 per year withdrawal without any other source of income would be a tough budget to live with here in Hawaii.

Uncle and I are days away from being able to withdraw without penalty from our retirement accounts. For now though, we will keep working and hopefully be able to contribute to our Roth IRA, and maybe our SEP IRA if we need to make adjustments on our income for tax purposes. It has been tough to have those extra dollars to contribute, so we shall see.

As an older person, my advice to young people is to put money into a retirement account. You may not really realize it, but one day you will be facing the golden years before you know it, and having a retirement cushion will be the best laid plan you have ever made.

Mahalo again Joe! I love this blog!


joe April 10, 2012 at 9:39 pm

I know, the $20K/yr isn’t much, but remember, that was the zero bracket amount. The next $17,400 is taxed at 10%, and then $53,300 at 15%. Just over $90,000/yr and still in the 15% bracket. Anyone in the 25% bracket who uses a Roth should think long and hard whether they are on track to have well over $2 million in today’s dollars at retirement.

Good to hear from you, Aunty, I appreciate your kind words.


Honolulu Aunty April 10, 2012 at 10:35 pm

Aloha Joe,

I got the book today! That sure was speedy! Of course the first chapter I read was on the Roth IRA – still seems to be the best of the best! Ed Slott calls it “the single best gift Congress has ever presented to the American taxpayer.” I think it is too.

I’ll be calling our retirement specialist to see if he can re-instate our Roth 401(K) that we just cancelled because of lack of use. It might be just what we need since the limitations on contribution to the regular Roth IRA are indeed limiting, and the older I get by the minute, the more beautiful the Roths look.

Mahalo again for the book and your lessons!



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