Does it Always Make Sense to Contribute to a Roth IRA? - Cravitz Financial & Insurance Solutions

Does it Always Make Sense to Contribute to a Roth IRA?

I love Roth IRA's. However, does it always make sense to contribute to one even if you are eligible to? I say definitely not always. In this video I describe a situation where I believe it's a bad idea. Instead, in this specific scenario I recommended they fund a Traditional IRA instead. As you approach retirement it's important to consider how your money is going to be taxed once you do retire.

Full Transcript:

Hey, everybody. It's Ryan here. All right, so is there any chance that you've ever heard that phrase before that goes, "It's okay to do it as long as you only do it in moderation?" Yeah, of course, you have. We all have. Right? And chances are, you probably have even said it yourself quite a few times. I know that I have. Of course, there's another one that goes, "Sometimes too much of a good thing is just too much."

All right, so I'm going to give you an example of exactly that in the financial world even more specific than that in the retirement income planning world. Now understand this first before I get into what I'm going to talk about here. I absolutely love Roth IRAs, and I love Roth 401ks. If you take qualified distributions from those in retirement, you can receive that money completely income tax-free, and I love tax-free income. Who doesn't it? Right? I don't think I'm going to get a lot of people to say, "No, no, Ryan. I want to pay taxes even when I don't have to." So, that's probably not going to be the case.

But certainly, I love tax-free income. But again, sometimes too much of a good thing is too much. Here's the scenario. A couple I was just talking to is now becoming a new client. I'm going to give you kind of the scenario here, at least that's relevant. I'm not going to give you the names or anything or any real specifics. In fact, I'm going to change things around a little bit. But here's the basic scenario. They're about 60 years old, both planning to retire in about three to five years, and interestingly enough, they've accumulated about $650,000 in their retirement accounts. But that's not the interesting part.

The interesting part is that all of that money now is inside of a Roth IRA. Actually, two Roth IRAs, his and hers. Basically, that's it. They've got a little bit of money in savings, four or five months of income, just emergency reserve type money. But that was really about it. As far as the assets that they've accumulated that they could use for retirement was almost only, in fact, maybe only, going to just come from the Roth IRAs.

Now, they're also going to have social security when they retire, and if they continue on based on how they're going, based upon the social security that they're projected to receive and the amount that we're projecting they can take out from the Roth IRAs, they would have to pay absolutely nothing in income tax. Now understand that what I'm going to talk about here certainly is my opinion and how I directed them in this scenario. I want to give you some things for you to be able to think about because everybody's situation is going to be different here.

The other thing is tax-wise is that every single state has a different tax system. Maybe some states are the same, but I couldn't tell you because I don't know all the 50 states' income tax systems. So everything I'm talking to you about here today is just on a federal level. So based on what they were doing so far, they would not have to pay any income tax in retirement, and so I applauded them. I mean, they've done a very good job.

Them, just like me, they believe that tax rates are going to go up in the future. I know I certainly do. Believe it or not, tax rates are about as low as they've ever been. I certainly believe that tax rates are going to go up. I know it doesn't feel like tax rates are about as low as they've ever been. But historically speaking, they actually are quite low. Also, our country is hugely in debt. So there's a lot of reasons why I believe tax rates will rise.

But nevertheless, here's the thing. They've done such a great job of putting money, investing money, contributing money to their Roth IRAs, but at this point, I told them to stop, and instead, believe it or not, because they were surprised at first, to fund a traditional IRA instead. In fact, not just one, but one for each of them. So he could put in 7,000 this tax year, and she could do 7,000 as well because they're over the age of 50. Right now, I'm recording this video in 2020, so in the future, those contribution limits could be different than they are this year.

But based on the scenario today, they could put away $14,000, or they could contribute $14,000 to their IRAs combined this year, and they could get a nice tax deduction. Now, at this point in their life, they're both making more money than they ever have. They're really in their peak earning years. So by contributing to a traditional IRA, they're able to get the tax deduction and the tax savings. Now you may be asking me the same question that they asked me. "Well, that's great, but isn't it also really nice to be able to get that tax-free income in retirement, especially if, like you just said, you believe tax rates are going to rise as well?" Here's why I didn't recommend it. Again, almost all other than the little bit that was in savings was it inside of a Roth IRA. In fact, all their retirement account money was inside of a Roth IRA.

They had no other income that they were going to receive that was going to be subject to income taxes. But there's a thing called the standard deduction, and without getting into all the details of how that works, you're allowed to have some taxable income for the year and not have to pay any taxes on it. And understand, again, I'm talking about taxes on the federal level here. So based on the projections, like we ran for them because they were going to have so such little money inside of the traditional IRA versus the amount that they were going to have in their Roth IRAs at retirement, that it made a lot of sense for them with the projections that we ran, they just took out a little bit of money each year from the traditional IRA because of the standard deduction, they would never have to pay any income tax at all.

So by funding the traditional IRA now, they get the tax deduction, and then in the future, they still won't have to pay any income tax, so a much better situation for them. So did they do a great job by funding in the Roth IRAs? Yes, as I've mentioned, and I've mentioned probably many, many times before, I love Roth IRAs. I love tax-free money. But sometimes too much of a good thing is too much. I hope this has been helpful. I look forward to talking to you soon.


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