Roth IRAs and 401(k)s: The Spinach of Investment Accounts

Roth IRAs and 401(k)s: The Spinach of Investment Accounts

April 26, 2024

retirement investment accounts

Roth IRAs and 401(k)s: The Spinach of Investment Accounts

April 26, 2024

Roth IRAs and 401(k)s that allow Roth contributions are incredibly powerful investment accounts. Once the money is in the account, it will never be taxed again: tax-free growth for life. Unlike 401(k)s that only allow pre-tax contributions, or Traditional IRAs, when your heirs inherit Roth dollars, there is no tax bill. And if you need the money during your lifetime, you can access the funds tax-free (with some restrictions).

So why do most savers have so little money in Roth accounts? I have a few theories – and they reinforce the reason almost everyone should contribute more to a Roth IRA or 401(k).

Reason 1: Roth accounts are the spinach of investment accounts. The benefits of Roth IRAs and Roth dollars within 401(k)s take decades to play out. You give up a tax break today, and the benefit of tax-free withdrawals usually comes in your 70s and 80s. By contrast, the benefits of saving into a Traditional 401(k) or IRA are immediate: a tax break in the current year. It's the difference between spinach and ice cream. It's bitter vs sweet now, but often worth the sacrifice.

Reason 2: Your CPA or financial advisor may be biased against a Roth. If they suggest deferring money into a Roth, there's no tax break today – so it looks like they have done nothing to help you reduce your tax bill. If they suggest contributing to a Traditional IRA or 401(k), you save tax dollars this year – and they are heroes.

Reason 3: Predicting the future is hard, so we just live in the present. Roth contributions today make the most sense if our tax rate in the future will be higher than it is today. That could be because we are far wealthier in retirement than we are now, because tax rates increase in the future, or because we are married today but widowed or single (and in a higher tax bracket) in the future. The most obvious candidate to make a Roth contribution is a 20-something with a low income today and a higher income in the future. But how many 20-somethings can imagine themselves in their 80s?

Reason 4: Contributing to a Roth is forced saving. We pay tax now, not later. Forced saving is hard, as the data on how little Americans save makes it painfully clear.

Reason 5: Many people need to recognize how large a tax bill they will leave their children under the new inherited IRA rules. Previously, when a non-spouse inherited an IRA, they were required to take a small percentage out annually over the projected balance of their life. That created a tax bill, but usually not overwhelming. As of 2020, an inherited IRA received by a non-spouse must be fully distributed over ten years. If the IRA is significant, that can create a huge tax bill. But if the beneficiary inherits a Roth IRA, there is no tax. I suspect, over the next decade or two, these new rules will make many heirs wish their parents had left them Roth IRAs.

Unless you're in the highest income tax bracket today, you should build up a Roth IRA or 401(k) balance. You can do that by contributing to a Roth or converting money from a Traditional IRA to a Roth IRA.

Learn more about the positive impact of a Roth IRA:

No, you won't thank me – because it will be painful today, and by the time you realize the benefits, I will be gone. But your future self will thank your present self.

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This article is not intended to provide tax, legal, accounting, financial, or professional advice. Readers should seek advice from qualified professionals who can review their specific circumstances. Old Peak Finance endeavors to provide information that is accurate and current. However, we cannot guarantee that this information has not been outdated or otherwise rendered incorrect by new research, legislation, or other changes. Old Peak Finance has no liability or responsibility to any individual or entity with respect to losses or damages caused or alleged to be caused, directly or indirectly, by the information contained on this website.

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