I’ve just discovered the inner politician in me. Look for me to run for office in the next election. Why am I all of a sudden a perfect fit for politics? Because I’m a flip-flopper. I recently took a stance on an issue and now I’ve done a complete about face. And like any “competent” politician I’m going to spin it so that I come out looking like I knew what I was doing all along.
Then: Roth IRAs are My Pal
Not too long ago, I advocated in favor of Roth IRAs in the facetiously titled article Roth IRAs Are Evil. Despite a solid argument against Roth IRAs made by Financial Samurai, I contested that Roth IRAs were right for me and my wife. I then provided a list of reasons why we were investing in them as one of our retirement planning strategies.
One of the main arguments I made in defense of Roth IRAs is that I firmly believe tax rates will be much higher in the future. With the national debt so high and with spending never really being reined in the country is going to need more revenue eventually. There’s just no way around it. So, where will our politicians turn? To us, of course. I think personal income tax rates will creep up slowly. In fact, it’s within the realm of possibility we could end up with income tax rates similar to some European countries. For that reason alone, an after tax retirement option in which future period withdrawals will not be taxed sounds like a solid approach.
Now: Bon Voyage Roth IRAs
That’s right, bon voyage to our Roth IRA accounts. Ok, so, the accounts aren’t actually going anywhere! We still have everything we’ve accumulated thus far. As of this month, though, I’ve discontinued my wife’s monthly contributions and reduced mine all the way down to $50 (previously we both were on pace to reach the maximum yearly contribution amount per individual which is $5,500).
Right about now you might be thinking I’m crazy to forego retirement savings. You could be right about the crazy part – I am a bit of a loon sometimes! – but I haven’t stopped saving for retirement. Instead, I’m now maxing out my 401(k) contributions. I’ve updated the withholding percentage from each paycheck so I’ll be on pace to reach the yearly 401(k) contribution cap of $17,500.
The Reasons I Stopped Investing in my Roth IRA
Here is why I’m taking a 180 degree turn and funneling my money into a 401(k) instead of a Roth IRA:
Taxes - While I still very much believe overall income tax rates will go up sometime in the future, I don’t necessarily think it will be so drastic of a change that I won’t be able to mitigate. Right now we are in the marginal tax bracket of 25% Federally and 9.3% as a California resident. Thus, everything I was pumping into my Roth IRA had already been taxed at marginal rate of 34.3%. I can easily knock 9.3% off that when I retire by moving to one of the states that does not have personal income taxes (such as Texas, Florida, or Nevada).
Another consideration is that we likely won’t be withdrawing as much in retirement as we currently earn. I don’ t know if that will be enough to drop us to the next lowest tax bracket of 15% (probably not), but at least we won’t be moving up a bracket. For simplicity’s sake, let’s say we are in the same bracket (albeit lower down the range). As predicted, in 30 years, the US has raised it’s overall rates up to deal with the national deficit. I automatically have a 9.3% cushion to work with since Texas won’t want my money! Even if the Federal rates for my bracket go up to 30-33% I won’t be any worse off in the future.
By making the switch to fully funding my 401(k), I estimate the following current period annual tax savings:
|Annual 401(k) Contributions: Prior||$ 6,838|
|Annual 401(k) Contributions: Now||$ 17,500|
|Difference: Reduction in Taxable Income||$ 10,662|
|Fed Income Tax Rate||25.0%|
|CA Income Tax Rate||9.3%|
|Total Estimated Yearly Tax Savings||$ 3,657|
Need More Money Now – This is the real impetus for our decision. We need more money now! We have a growing family and, while our rented apartment is fairly upscale, we are fast outgrowing the smaller confines. With plans of a second child in the not-so-distant future, we’d like to expand our household by purchasing a home. The problem? California real estate prices are insane. In my region, the average home sells for a shade under $300,000. That means we need at least $60,000 for a 20% down payment. Plus, we’d require additional funds for regular living expenses and a buffer for emergencies. We’ve got a way to go to hit this lofty savings target so $3,657 in current period tax savings surely will help.
I’ll Miss You, Roth IRA
I still think Roth IRAs are an excellent retirement savings option. If it weren’t for the reasons I outlined above then we’d most definitely still be fully funding our Roth IRA accounts. It was a tough decision to make the switch and perhaps it will only be temporary. If/when we accomplish our goal of purchasing a house, I envision us shifting back to our Roth IRAs. I will admit, in a way, I feel like I’m am screwing over the “future Mr. Utopia” for short-term gain. However, once I shake those emotions away and take a more cerebral look at things, I think the move is a solid one for our family.
Am I foolish for virtually ceasing Roth IRA contributions? Is my new strategy going to cost me in the long run? Too much short term gain? Let me know what you think…