Roth IRAs: An Opposing View

Posted by Drew on May 8, 2012

Meet the new writers! Our next new writer is Drew. Drew has always had a fascination with varying strategies for handling finances and economics throughout the world. He loves to travel and has a goal of reaching all 50 states and at least 30 countries before he hits 40 years old. He is currently pursuing his MBA, and has a primary goal of retiring from the corporate world by his mid forties. You can read more about Drew in his bio. Welcome Drew!

Roth IRAs: My Views

One of the first topics that I have been asked to write about is my views on the Roth IRA. I have a Roth, and I don’t discount the benefit of a structured retirement account. However, there are some limits on the usefulness of this retirement vehicle. Growing funds tax free is definitely a benefit for those that have a need for future retirement.

There are some things which don’t make sense if you have certain situations which make a Roth IRA not as beneficial as you think. If you get the benefit of being below the Adjusted Gross Income (AGI) requirements and getting the retirement savers tax credit you might make things a little better for yourself. The flip side is that if you make too much, you cannot contribute to a Roth IRA.

Who am I?

So let’s see how this applies to me. I am a 37 year old professional who is a single parent who files as head of household. I make more than $42,375 in AGI every year, thus I get no tax credit from owning a Roth. I on the flip side typically make more than the low limit for Modified Adjusted Gross Income (MAGI – your income, minus a few things, but none of your deductions like AGI). So what does this mean for me? I cannot contribute to a Roth, and get no tax benefit from contributions to a Roth.

Roth IRAs: Why They Don’t Make Sense for Me

So what does this mean for me? I define retirement a little different than most people. I strive to work as hard as I can and then leave the corporate realm. I might go back and do something else but the reason is not for earning the paycheck, but for the fun of it. This is where the problems with structured retirement plans come into play. Yes you can take out your contributions (just the contribution amount) tax free, but you cannot take out any of the profit. Therefore part of your retirement savings is sitting and cannot be touched until you hit retirement age (unless you want to pay the fines and taxes). One of the mantras that I have heard over time is never take your principal out of an investment unless you are cashing out. Taking the principal out of the accounts will leave less money to grow on, and thus have less money in the future of your accounts. Well think of it this way, you are leaving behind the earnings that you have earned and it is sitting in your account for decades until you can touch it when you “legally” are able to retire should the government not change the official retirement age of retirement vehicles (which again they are talking about).

As with many of the government laws that are created, they use the broad brush stroke approach and apply to the lowest common denominator. This means that while IRAs are a benefit for those who are not disciplined in their retirement finances, it hurts those of us who are disciplined. Since I plan on retiring early, gaining access to my retirement accounts will be a necessity so that I can actually maintain my living standard. There are other things which will help (namely paying off all debt, mortgages, etc.) as well as having enough “money” to live off the interest/dividends that you will earn year over year.

How I Save for Retirement

So what am I doing to combat this as I have to save for retirement, but don’t use Roth or other retirement accounts (unless they make sense)?* I do a majority of my “savings” with a taxable account and therefor have a couple of different options that apply to the future. Don’t get me wrong, I have a rollover IRA (from former 401ks), a Roth IRA, and a couple regular taxable accounts. This means that I can have access to some (depending on how much is in which account) of my money, yes it is taxed, at any time I want. Should I retire at 45 or 55 or 65, I can get access to the majority of my money and go on a world cruise and not have to worry about taking the money out of my retirement accounts with tax liabilities when I retire early. There are other issues at play here, but that is for future articles.

*Such as when the tax benefits work if I don’t make too much income, or I have a company matched 401k, etc.

Do you favor Roth IRAs or taxable accounts?

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Comments to Roth IRAs: An Opposing View

  1. Have you heard of 72(t) withdrawals? If you retire early you can access you IRA/Roth/401k money without penalty as long as you take five substantially equal payments over fiver years. So you can still contribute to the Roth without worrying about locking up your money until age 59.5.


    • Dave – Yes I have heard of the 72(t) withdrawals and they work for some people, however the biggest issue is the SEPP (Substantially Equal Periodic Payment) requires you to use the life expectancy as a basis for what you can take out of the IRA. I am saying that if you retire early, and want to utilize your nest egg prior to that, you cannot do it very well. Putting all your eggs into one retirement basket and you retire by 45 lets say. According to the life expectancy of the government for me is 85 year old. That is 1/40th of the amount I can take out of my IRA due to the SEPP. That is not access to my money, it is a pittance of what is in there, and enough for one months mortgage payment, not enough to live on for a majority of the year.

      Yes your money is not 100% locked up until you hit “official retirement age” but essentially you cannot get access to the majority of it without taxes and penalties until you hit 59.5. There are people out there that living to 60 is a pipe dream and there is no way around the rules the government set forth. If you are in that class of people, then utilizing something that puts a majority of your savings into this type of account, it does not make sense for you.

      The only way I can see this working is if you take out 100% of your contributed amount, and do SEPP on the remaining gains. That might be a viable option for gaining access to your funds when you retire. Again, I am not utilizing a ROTH exclusively, for this reason, which was more the point of the article.


      • There are several methods you can use to calculate SEPPs. The method you describe (RMD) gives the smallest payout. Using the amortization or annuitization method will give payments of around 4% (1/25th of the account balance), which is the maximum most advisers recommended taking out anyway. Plus as Josh mentioned you could take out all of your Roth contributions penalty free. If that is still not enough I would argue you don’t have the funds to retire at 45 anyway and would likely run out of money even without the 59.5 restrictions. I don’t think you have really thought your plan through completely.


    • I agree with you Dave, I think it’s a bit shortsighted. If all you are saving for retirement is $5k per year you likely won’t be able to retire by 45 so the bulk of your savings will be in taxable vehicles anyway. Add to that that you will be able to take out all of your contributions then do a 72t on the remainder and it’s a no brainer in his situation. If you’re going to need to live off of the gains in your roth before you hit 59.5 because you’ve used up all the taxable money and all the roth contributions, you better have one huge 401k. And if you 401k is that large you’d be able to convert to an IRA and do a 72t on it anyway. I think it might be a good idea for you to run the numbers before deciding to pay more money in taxes by not using a Roth rather than just discounting it because of the “lock up”.


  2. Even if you are above the MAGI threshold for contributions, you can make a nondeductible contribution to a traditional IRA, then immediately convert it to a Roth. It provides you with the same tax-free growth as a regular Roth contribution would, only you don’t get the benefit of withdrawing the contribution at a future date without penalty.


    • @Executioner – You stole my thunder! I too was going to mention the non-deductible Traditional IRA contributions followed by a conversion as a viable option for high income earners. However, I agree with what Drew writes. There’s a lot to be said about investing in a regular taxable account that you continually have access to and control over. I prefer to buy well-diversified index funds that I can theorectically hold forever (thus avoiding capital gains tax), then I just pay the taxes each year on the continually increasing stream of dividends which I use to pay for my expenses in the here and now.


  3. If you need to be drawing earnings from your Roth before 59.5 then I would argue that you are in no position to be retiring early.


  4. Everyone’s situation is different. I love IRAs and recommend them to lots of people. The only reason I wouldn’t is if they are NOT maxing out their 401K match at work (if they have that option.) I would take free money any day! Once you are contributing to that account to the max match then go for the IRA

    Katie Christianson

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