- Bargaineering - http://www.bargaineering.com/articles -

Why Roth IRAs Are Bad

Posted By Jim On 02/14/2007 @ 5:55 pm In Devil's Advocate | 33 Comments

When you get both sides of something, you know, at the very least, that there are some smart people looking at it and you can try to piece together a full picture and form your own opinion on something. When was the last time someone said that investing in a Roth IRA is a bad idea?

Yeah, I haven’t met anyone who has told me that a Roth IRA was a bad idea either and almost everyone I’ve met has said that the Roth IRA is fantastic, wonderful, a must for everyone; so… who’s giving the other side? Well, in this Devil’s Advocate [3] post, I’m going to try to provide this other side and here are the reasons why I think Roth IRAs are a bad idea!

You Can’t Assume The Tax Structure Will Remain The Same

In the last few years we’ve already seen people suggesting alternate means of taxation to do away with the monstrosity of income tax and the Internal Revenue Service, to go with a flat tax, or a value added tax, or some other form of non-income related tax. What if we did go to something like that? Well, the benefit of a Roth IRA is that you pay the income taxes now so you don’t pay them on disbursement and if there was no income tax then you lose that benefit. If let’s say we instead instituted an automatic 20% national sales tax and abolish the income tax, then your Roth IRA would in essence be double taxed. Now, if we were to make a change, I’m sure there would be some grandfather clause so that no one was penalized but maybe not!

Roth IRA’s Are Not Incredibly Better Than Traditional IRA’s

Often times when you hear someone talk about Roth IRA’s, they talk about how they’re ridiculously better than Traditional IRA’s, except they’re not. With traditional IRA’s, you have a bigger piece of pie to invest now with the spectre of taxation in the future; with Roth IRA’s, you have a smaller piece of pie to invest now but without taxation hovering over your earnings. While it sounds nice to not pay taxes on your earnings, it really works out to be approximately the same if your rate of taxation remains the same. The reason this is so is because what you pay now in taxes on your Roth IRA contribution would be otherwise invested and make up for the amount in taxes you’re skipping out on by prepaying. Hopefully that made sense…

You Can Withdraw Your Contributions Without Penalty

If you withdraw early from your 401K, you face a 10% penalty on top of your regular income tax. If you want to withdraw your contributions from a Roth IRA, they let you without penalty as long as you follow a few simple rules. This is great, except if you are the type that can’t resist taking out the money (once it leaves, you can’t put it back in), then this is a bad thing since there aren’t any obviously negative effects (such as 10% off). Sure, this is a weak argument against Roth IRAs (and often touted as a benefit) but the fact remains some savers like the idea of a penalty so that they aren’t tempted to withdraw the money.

As you can see, Roth IRAs aren’t the holy grail of retirement investing and the tax free growth isn’t as miraculous as it may seem. Personally, I’ve put as much as I can into my Roth IRA (which really isn’t all that much anyway, it’s certainly not the $15k limit of 401Ks) each year so even if you were to go full tilt on Roth IRAs, you aren’t really in a bad shape if things turn out badly. It’s just useful to know that while a Roth IRA is a very important piece of your retirement savings puzzle, don’t let all the talk of its awesomeness overshadow the fact that its use as a retirement vehicle does have risks involved and hopefully in this Devil’s Advocate [3] post I’ve laid some of them out for you.

If you know of any that I’ve missed, please do share and I’ll try to integrate them with the post. (I do admit that making this argument was difficult past the first reason, so keep that in mind!)


Article printed from Bargaineering: http://www.bargaineering.com/articles

URL to article: http://www.bargaineering.com/articles/why-roth-iras-are-bad.html

URLs in this post:

[1] Tweet: http://twitter.com/share

[2] Email: mailto:?subject=http://www.bargaineering.com/articles/why-roth-iras-are-bad.html

[3] Devil’s Advocate: http://www.bargaineering.com/articles/category/devils-advocate/

Thank you for reading!