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If you are looking for a retirement account that is both flexible and easy to manage, then the Roth IRA might be right for you.
Additionally, it offers many benefits that make it superior to traditional IRAs.
But this doesn’t mean a Roth IRA doesn’t come with some disadvantages.
In this post, I walk you through important pros and cons of Roth IRAs that you need to understand.
Once you know these things, you can make an informed decision on which type of retirement account is right for you and your financial goals.
Table of Contents
10 Critical Pros And Cons Of Roth IRAs
5 Pros Of Roth IRAs
There are many benefits of investing in a Roth IRA.
Here are the biggest ones that effect most investors.
#1. Tax Free Withdrawals
A major advantage of Roth IRAs is that you get tax free money in retirement.
The money you invest in your account grows tax free and the interest, dividends and capital gains you earn also grow tax free.
When you take distributions from your account, there is zero tax to be paid.
This tax free growth is the main reason why so many financial professionals recommend individual investors begin investing in a Roth IRA account as soon as possible.
#2. Ability With Withdraw Contributions Early
With most retirement plans, like your 401k plan or traditional IRA, you cannot withdraw money before retirement age 59 1/2.
If you decide to, you not only pay income tax on the money, but penalties as well.
And this withdrawal penalty can quickly destroy your wealth.
With a Roth IRA however, you don’t have to worry about this.
This is because you contribute to a Roth IRA with after tax dollars.
Since you already paid taxes on this money, you are free to withdraw it without worry about paying taxes or penalties.
Understand this only applies to the money you contribute to your account, not the earnings.
For example, if you contribute $5,000 and your Roth IRA is now worth $15,000 you can only withdraw $5,000 tax and penalty free.
Because of the fact you can take early withdrawals tax free, many people use their Roth IRA as a nice backup emergency fund.
Finally, there are provisions for first time home buyers where you can take qualified withdrawals without penalty.
You can even withdraw money for educational purposes too.
The catch for both is the money needs to be invested for at least years, also known as the five year rule, and you can only withdraw $10,000.
#3. No Required Minimum Distributions
Another great benefit is that there is no minimum required distribution.
With 401k plans and traditional IRAs, the government forces you to start taking mandatory withdrawals, also called required minimum distributions, when you turn age 72.
With a Roth IRA, you don’t have to start taking money out at this age, or ever for that matter.
In fact, you could decide to never touch the money and pass the account to one of your heirs.
#4. Many Investment Options
With Roth IRAs, you have many investment choices you can invest in.
You can choose to invest in individual stocks, mutual funds, exchange traded funds, certificates of deposit, real estate, precious metals, and more.
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This is great for investors who want the option to invest in other asset classes besides stocks and bonds.
It also is an easy way to build a diversified portfolio as well, since you have so many asset classes to choose from.
#5. Easy To Open Roth IRA
One of the great key benefits is it is easy to open an account.
Most brokers, even robo advisors offer the ability to open a Roth IRA account.
And in most cases, you can open an account online in minutes.
If you don’t have a financial advisor or financial planner, you could even go to your local bank or other financial institution and open a Roth IRA there.
5 Cons Of Roth IRAs
As beneficial as Roth IRAs are, they aren’t perfect investments.
Here are the biggest drawbacks of Roth IRAs.
#1. Pay Taxes On Contributions
As I briefly mentioned earlier, you make after tax contributions on the money you invest in your Roth IRA.
While this does allow your money to grow tax free, it can be issue if you crunch the numbers.
A great example is if you are in a higher tax bracket today versus retirement.
For example, let’s say you are in the 22% income tax bracket today.
If you contribute $5,000 into your account, you are paying $1,100 in income taxes on that money.
When you retire, because you don’t have as much earned income, you might be in the 10% income tax bracket.
Had you invested the money in a traditional IRA instead, you would have avoided taxes when you contributed the money and paid the taxes now.
In this case, 10% tax on $5,000 is $500.
This is a tax savings of $600.
While this is a negative, you have to remember that income tax rates aren’t set in stone.
And you never know what your income will look like come retirement.
In other words, don’t avoid a Roth IRA for this reason alone.
#2. Low Annual Contribution Limits
A major disadvantage of a Roth IRA is that you can only contribute a certain amount per year.
For 2021, this annual contribution limit is $6,000.
If you are over age 50, you can make catch up contributions for another $1,000 per year.
Compare this with the limit of over $18,000 for a 401k plan and you can see why this is a drawback.
However, if you start investing at a young age and are able to contribute the maximum contribution amount allowed, you could build a sizeable nest egg come retirement.
And this will be tax free income in retirement.
#3. Income Limitations
As annoying as it is having contribution limits, there are also an income limit to a Roth IRA.
Single taxpayers, their modified adjusted gross income or MAGI must be less than $140,000 and for married taxpayers filing jointly, the limit is $208,000.
The good news here is this allows a good number of people to invest in a Roth IRA and take advantage of its many retirement planning benefits.
Also, understand that the income limits are not a hard line.
There is a small window where, depending on your income, you might not be able to make a full contribution but make a partial contribution.
#4. Contributions Don’t Lower Adjusted Gross Income
Another downside is that your Roth IRA contributions don’t lower your adjusted gross income.
When you make traditional IRA contributions or contributions to your 401k plan, these are tax deductible contributions.
This means you can write these off on your taxable income.
This gives you a tax break, and as a result, lowers the Federal income tax you owe.
For example, let’s say you earn $40,000 annually and are in the 20% tax bracket.
To keep things simple, we will ignore the many deductions and credits you might qualify for and assume you take none.
In this case, you owe $8,000 in income taxes.
But let’s say you contribute $5,000 to your 401k and $5,000 to your traditional IRA.
You can take this $10,000 off of your earned income.
Now your earned income is $30,000 and 20% of this amount is $6,000.
You saved yourself $2,000 in taxes by contributing to your retirement accounts.
This could mean a larger tax refund check for you.
If you instead only invest in a Roth IRA, there is no tax deduction.
So you if make $40,000 and contribute $5,000 to your Roth, you still owe the full $8,000 in taxes.
It’s important to understand the tax implications of investing in any of the retirement accounts so you are making the best choices for your financial situation.
#5. You Are Responsible For It
Finally, when it comes to your Roth IRA, you are responsible for it completely.
Assuming you don’t have a financial professional, you must open the account, choose your investments, and monitor the growth.
At least with a 401k plan, the investments are chosen for you and your human resources department handles the paperwork of setting your account up for you.
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For new investors or seasoned investors, all this responsibility might be too much and as a result, decide not to open an account.
There are the important pros and cons of Roth IRAs you need to know.
While Roth IRAs aren’t perfect, the fact that you can grow your retirement savings tax free makes this account a must have for all investors.
Even if you think you will be in a lower tax bracket come retirement, you still should consider a Roth.
This is because the odds are taxes will be higher in the future and having the ability to tap tax free money is priceless.
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I have over 15 years experience in the financial services industry and 20 years investing in the stock market. I have both my undergrad and graduate degrees in Finance, and am FINRA Series 65 licensed and have a Certificate in Financial Planning.
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