1. Your tax rate could go down in the future
When you contribute money to a Roth IRA, you don’t get immediate tax relief. Instead, your tax savings come in retirement, when you are entitled to withdrawals that are not subject to tax. Savers are often encouraged to choose a Roth IRA if they believe their tax rate will increase during retirement. This way, they pay tax on their money at a lower rate and then enjoy tax-free withdrawals when subject to a higher rate.
But what if your tax rate doesn’t end up being higher in retirement? What if tax reform cuts rates across the board, or if your personal circumstances put you in a lower tax bracket as a senior than you currently do? In this case, you lose the tax benefit that may have inspired you to save in a Roth IRA in the first place.
2. You may need to make annual retirement withdrawals
The Roth IRA is the only tax-advantaged retirement plan that does not impose minimum required distributions, or RMDs. RMDs can be a problem in traditional pension plans because they create a tax liability, but even for Roth 401 (k) savers, they can still be a nuisance – not least because by withdrawing funds from your account, you lose the opportunity to continue enjoying tax-free investment growth on your money. Many people therefore prefer the Roth IRA because they will not have to deplete their accounts before they are ready.
But what if you end up needing large sums of money from your Roth IRA? Suddenly you take distributions and lose that tax-advantaged growth anyway, negating a major Roth IRA benefit.
3. The temptation to withdraw money before retirement may leave you behind later
Withdrawing money from a Traditional IRA before the age of 59 1/2 will usually result in an early withdrawal penalty of 10% on the amount you withdraw. But with a Roth IRA, this penalty does not apply, as long as you take withdrawals from the main part of your account, not the interest part. The reason? You’ve already paid taxes on that money, so why should you be penalized for taking it back?
This flexibility, however, poses a problem in that it may prompt you to take early Roth IRA withdrawals for no good reason. It’s one thing to tap into your retirement savings in an emergency, but knowing that you can dip into your capital at any time could lead you to make some bad choices that, in the end, leave you behind. a shortfall as you approach your final years.
Let’s be clear: there are many good reasons to save for retirement in a Roth IRA. But before you make that decision, be aware of the ways that this could backfire on you. This way, you will be less likely to regret your choice later in life.