Why You Might Not Want To Put All Your Retirement Savings Into Roth

If you have the option of making Roth contributions to your employer’s retirement account, should you do it? With a traditional pre-tax contribution, you only pay taxes when you withdraw the money. With a Roth contribution, you pay the taxes before you contribute, but the earnings can be withdrawn tax-free as long as you’ve had the account at least 5 years and are over age 59 ½.

The ‘gurus’ may not always be right

I recently spoke to one employee who has made all Roth contributions and so virtually all of her retirement savings (except for matching contributions) is in a Roth 401(k). When I asked her why, she said it was because she heard from Suze Orman and Dave Ramsey that this was a good thing to do.

One of the problems with taking financial guidance from media personalities is that their advice tends to be overgeneralized. In this case, I’d say it’s worse than that because I would argue that most people are better actually better off making mostly pre-tax contributions even if they retire in the same tax bracket!

It’s still a good idea to have some pre-tax savings

When this employee retirees, almost all of her income will be tax-free. (Her taxable income will be low enough for her Social Security benefits to be tax-free and her husband has no retirement savings.) That sounds great except that if she and her husband were retired today, they would still be eligible to have at least $24,400 of tax-free income in retirement because of their standard deductions, even without the Roth.

If she had contributed to a pre-tax 401(k), she would have paid no tax on the contributions and then no tax on $24,400 of withdrawals each year. (The next $78,950 would still only be taxed at 10 or 12%, much less than the tax rate she would have avoided on her contributions.)

Not too late to fix it

The good news is that she still has plenty of time to make future pre-tax contributions and lower her current taxes before she retires. This would allow her to either save more and/or use the tax savings for other goals. However, her projected retirement income based on these future contributions would still not allow her to take full advantage of her standard deductions in retirement.

It’s still a good idea to have some Roth

This isn’t to say that everyone should make all pre-tax contributions either. There are good reasons to have at least some money in a Roth account, especially if you plan to retire before you’re eligible for Medicare at age 65 since having some tax-free income can lower your health insurance premiums in the exchanges.

A Roth account can also be more beneficial if you think your tax brackets will actually be higher in retirement. Roth IRAs also have other benefits in terms of more flexibility with investment options and withdrawals.

The moral of the story

So what’s the moral of the story? Don’t always believe what you hear or read from so-called “financial gurus.” Their advice/entertainment is meant to be generalized and may be misapplied to your situation. Instead, seek out more personalized guidance from a qualified and unbiased financial planner.

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