Wait Roth IRAs Actually ARE Evil!

roth ira flip flopI’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 Rate25.0%
CA Income Tax Rate9.3%
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…

Image courtesy of numb3r5 at Flickr.

24 Responses to Wait Roth IRAs Actually ARE Evil!

  1. Holly@ClubThrifty September 10, 2013 at 6:47 am #

    I have a Roth IRA and I continue to contribute to it. However, I have some of the same fears as you do. It’s just hard to plan when we don’t know what is going to happen tax-wise over the next few decades. I’m only 33 so who knows how things will be once I reach retirement age.
    Holly@ClubThrifty recently posted…Cash Money: $6,605 in August Income and Blog UpdatesMy Profile

    • Mr. Utopia September 11, 2013 at 5:34 pm #

      The best approach is probably to diversify – fund both a Roth IRA and a pre-tax account. That’s what I was doing previously, but the need for cash money now has lead me to make the switch.

  2. DC @ Young Adult Money September 10, 2013 at 9:54 am #

    I think your rationale makes sense, and I hope you guys find a great house for your family!
    DC @ Young Adult Money recently posted…4 Things I love about Cub FoodsMy Profile

    • Mr. Utopia September 11, 2013 at 5:36 pm #

      Thanks, DC. We’ve got a considerable ways to go although buying a house is a moving target. Prices here have appreciated 30+% over the past year, so at this time a 1.5 years ago we would’ve been much closer. Seems to be cooling off a bit…

  3. Financial Samurai September 10, 2013 at 10:46 am #

    Congrats for coming to your senses!

    BRAVO! Let others pay for our government bloat!
    Financial Samurai recently posted…Real Estate Investment Mistakes To AvoidMy Profile

    • Mr. Utopia September 11, 2013 at 5:37 pm #

      Thanks for the standing ovation, Sam!

  4. Mike September 10, 2013 at 11:14 am #

    I’ve also elected to put more focus on things that generate cash in the near- to medium-term vs the long-term. I have the benefit of a pension, but wanting to have a large sum of money for our next house purchase, or to invest in a business, etc., makes a lot more sense for us!
    Mike recently posted…Lending Club and Prosper Review: Video UpdateMy Profile

  5. retirebyforty September 11, 2013 at 8:18 am #

    I still like the Roth IRA and will continue to max it out every year after I max out 401k contribution.
    If you’re in the 25% bracket, the tax advantage is not that high. Good luck with the house search. Hopefully you can contribute to both Roth IRA and 401k in the future.
    retirebyforty recently posted…7 Compelling Reasons to Use Cash Instead of CreditMy Profile

    • Mr. Utopia September 11, 2013 at 5:50 pm #

      I’d like to continue contributing to the Roth IRA – it really was hard to pull the trigger on this switch. Overall, I’m still contributing pretty much the same amount to retirement, it’s just all in the 401(k) now.

  6. Jon @ MoneySmartGuides September 11, 2013 at 9:46 am #

    I think that you made a good decision based on your points. The keys will be to actually move when in retirement to avoid the state tax and to simply just keep saving for retirement.
    Jon @ MoneySmartGuides recently posted…Chicks Don’t Dig The LongballMy Profile

    • Mr. Utopia September 11, 2013 at 5:53 pm #

      Thanks, Jon, for the feedback. As far as the moving goes, I envision establishing residency in a no income tax state, but being fairly nomadic. That’s a long way off, so we’ll see how that goes.

  7. Andrew@LivingRichCheaply September 11, 2013 at 10:07 am #

    I contribute more to my 403b at work for the same reasons that you listed above…high taxes in NYC and needing more money now to purchase a house in a high cost of living area. However, in the long run, for me I think the Roth is better because I’ll have a pension so I might still be a higher tax bracket when I retire and I don’t think I’ll be moving to a low tax state either. So I contribute a little to the Roth also.
    Andrew@LivingRichCheaply recently posted…Are you Lured in by Sales?My Profile

    • Mr. Utopia September 11, 2013 at 5:54 pm #

      Makes sense, Andrew, since the payments from your pension will be taxed. I’m envious of the pension!!

  8. Untemplater September 11, 2013 at 10:17 pm #

    I used to think Roth’s were good too but I don’t promote them anymore. I still have one that I haven’t shut down but I don’t trade in it either because the fees are so high.
    Untemplater recently posted…Why Communication Fails At Work And Ways We Can Fix ItMy Profile

    • Mr. Utopia September 14, 2013 at 10:25 am #

      High fees are bad no matter what type of investing you’re doing. And, unfortunately, the fees are higher in my 401(k) than my Roth IRA. So, the switch I’ve made is more expensive in that regard. I’m still saving ~$3,600 in current period taxes though and, right now, short term goals are trumping long term.

  9. john September 22, 2013 at 5:19 pm #

    A Roth Ira is a better investment to me then a 401(k) but everyone’s situation isn’t the same…. Just do your research and choose the right investment for yourself.

  10. thepotatohead October 1, 2013 at 8:26 pm #

    I just was able to bump up my contributions in the 401k to the max of $17,500. I’ll need to crunch the tax numbers again, but next year when I get a raise I should be able to contribute to a Roth IRA and be in the 15% bracket, so I will probably do that. If most of my contributions end up being in the 25% bracket I might change my mind and do different things with my money. Time will tell.
    thepotatohead recently posted…My Experience With BioLife Plasma ServicesMy Profile

    • Mr. Utopia October 2, 2013 at 5:56 pm #

      I like that you’re thinking ahead. It’s always good to have a plan even if it’s tentative at best. It almost sounds like you don’t want too big of a raise though which is a bit ironic!

    • Mr. Utopia October 6, 2013 at 12:35 pm #

      Hey, Zimmy, yes, I’ve definitely considered relocating (although not specifically due to Roth IRA considerations). In fact, I wrote about this exact topic very recently. http://www.personalfinanceutopia.com/2013/09/relocate-improve-personal-finances/

      Also, I used to live in Texas and would love to return. Unfortunately, I have no family there anymore (they’re all mainly here in California).

  11. Zee April 5, 2014 at 12:18 pm #

    The IRA debate lives on forever… I use my Roth IRA to diversity my retirement savings. I’m not too worried about the tax rates when I retire, they may be higher, but I don’t think that they will be significantly higher.

    BUT, the main reason I like my Roth IRA is because I don’t get hit by capital gains taxes. If you are someone that actively invests this advantage could be huge. One year my balance in my Roth IRA increased from about 50k to 120k because I put a large chunk of that into a company that skyrocketed. I realize that I was very lucky in that outcome but now I have a great head start on this account and I won’t have to pay a cent for any of those capital gains. I think that a Roth IRA could be a great place to chase those unicorn stocks, just don’t put all your money into one place!
    Zee recently posted…Why is saving money such a stigma?My Profile

    • Mr. Utopia April 8, 2014 at 7:46 pm #

      Wow, $70k appreciation in one year is phenomenal. Hopefully you were able to rebalance/diversify to maintain that growth. Yes, not having to pay any tax on the capital gains can be very huge. To me, that’s the strongest advantage of a Roth IRA especially if you’re able to hit a home run like you did. Ideally a person would max out both pre-tax retirement accounts and their Roth, but most people aren’t in a position to do that. It really comes down to the individual financial situation you’re in. For us, right now, I want to save on taxes in the current period so we can more quickly save up for a down payment on a house. After that goal is accomplished, I can envision shifting back to fully funding my Roth at the expense of maxing out my 401(k).

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