There's a reason financial experts have long touted Roth IRAs as an optimal savings tool. Roth IRAs offer a number of key benefits that traditional retirement plans can't match.
Your financial adviser may remind you that traditional IRAs provide a tax break on funds contributed, and earnings get to grow on a tax-deferred basis. However, when it comes time to withdraw those funds, retirees are then dealt the blow of taxes on withdrawals.
Worse yet, traditional IRAs eventually require savers to draw down their funds in the form of required minimum distributions (RMDs). Those not only result in a loss of tax-deferred gains but also create what could be a substantial tax liability.
Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
Roth IRAs, on the other hand, do not offer a tax break on contributions. Instead, they offer tax-free gains and withdrawals, both of which could be invaluable to Americans who wind up in a higher tax bracket than expected later in life.
Furthermore, Roth IRAs don’t impose RMDs, which means savers can enjoy tax-free gains in their portfolios indefinitely. For this reason, Roth IRAs can also function as estate-planning mechanisms, allowing savers who don’t need all their money in retirement to leave a legacy behind to their heirs — and a tax-advantaged one at that.
But there’s a dark side to Roth IRAs that isn’t talked about as much. And it’s important to understand the pitfalls.
1. Higher earners are barred from direct contributions
There are no income limits associated with traditional IRA contributions. Not so with Roth IRAs. Higher earners commonly hit a snag by not being able to fund a Roth IRA directly.
The income thresholds at which contributions are barred change annually. In 2025, direct Roth contributions are off the table for single tax filers earning $165,000 or more, or married couples filing jointly earning $246,000 or more.
Of course, there may come a time when Roth IRA income limits are lifted. The country is deep in the throes of a retirement savings crisis, according to Aaron Tallen, VP, Head of Distribution Ops & 401k Defined Contributions at Security Benefit. So lawmakers may opt to change the rules to incentivize people to save for retirement.
For now, Tallen says, “People need to realize they can take advantage of conversions.” But that introduces a world of complication, as Roth conversions done in one fell swoop could have serious tax implications.
2. There's still uncertainty around taxes
Some financial experts say that we’re in a period of historically low tax rates. But ultimately, we don’t know what the future holds for tax rates. And that’s another potential pitfall of Roth IRAs.
The nice thing about Roth IRAs is that they offer protection against future increases. But Tallen warns that it’s not a given that you’ll be in a higher tax bracket in retirement than you are today.
"There's the uncertainty of ‘I know where my tax bracket is today, but I have no idea what my tax obligation will be in the future,’" he says. Tax code changes and life circumstances could make it so that the time to optimize tax breaks on retirement savings is during your working years, not retirement, making a Roth IRA a less optimal choice.
3. It's almost too easy to take an early withdrawal
Since Roth IRAs don’t give you a tax break on contributions, you’re free to withdraw your principal contributions at any time without a penalty. That might seem like a great thing, since it gives you flexibility. But Terry Parham, Co-Founder, Financial Planner, CFO, and CCO at Innovative Wealth Building, says it’s not.
"It's a less effective forced savings," he explains. And that worries him, because if Roth IRA savers don’t have early withdrawal penalties to worry about, they might raid their accounts ahead of retirement and get stuck with a shortfall later on.
4. You need tax diversification to take advantage of IRS benefits
While Parham is a fan of Roth IRAs, he feels that having 100% of one’s money in a Roth account is not a great thing.
"Tax diversification is the name of the game," he says. “You should have some level of pre-tax assets [in retirement] to get certain tax benefits.”
For example, Parham says, it’s not unusual for well-off individuals to want to donate to charity during retirement. But people in that boat can potentially benefit more from traditional IRAs than Roth IRAs. That way, they get the up-front tax break on the money they put in plus the tax break on qualified charitable donations (QCDs) once RMDs come into play.
“There's no tax break for doing a QCD from a Roth IRA,” Parham explains. “So you're better off getting the tax break on the traditional IRA and then doing a QCD.”
Parham also notes that we don’t know what tax breaks may be coming down the pike. “It could be that there’s a new non-refundable tax credit the IRS makes available,” he says. “If you don't have enough income, you don't get the credit.”
For this reason, Parham warns against going all-on on Roth IRAs. Having some taxable retirement income isn’t a bad thing, he insists.
Read More
-
E-ZPass Scam Texts are Still Going Around. Here's What to Look Out ForScammers have been sending fake texts about E-ZPass for over a year. Know what to look out for and what to do.
-
A Savings Tool to Empower People With DisabilitiesAn ABLE account can improve quality of life for individuals with a disability — it permits tax-free saving for ongoing expenses without jeopardizing benefits.
-
ABLE Account: A Savings Tool to Empower People With DisabilitiesAn ABLE account can improve quality of life for individuals with a disability — it permits tax-free saving for ongoing expenses without jeopardizing benefits.
-
Social Security Fairness Act: Five Financial Planning Issues to RevisitMore money as a public-sector retiree is great, but there could be unintended consequences with taxes, Medicare and more if you're not careful.
-
Social Security Warning: Five Missteps Too Many Women MakeClaiming Social Security is complicated, and for women the stakes are high. What you don't know can cost you, so make sure you do know these five things.
-
To Buck the Third-Generation Curse, Focus on the Family StoryThe key is to motivate the next generations to contribute to the family business in a productive way. You can look to Lawrence Welk's family as a prime example.
-
20 Ways to Clean Up Your Finances This SpringSpring cleaning is therapeutic and stops costly problems from building up around the home. Why not tackle the dusty corners of your finances at the same time?
-
How Roth Accounts Can Ease Your Tax Burden in RetirementStrategic Roth IRA conversions can set you up for tax-free income in retirement and a tax-free inheritance for the people you love.
-
Are You a High Earner But Still Broke? Five Fixes for ThatIf you're a HENRY (a higher earner, not rich yet) but feel like you still live paycheck to paycheck, there are steps you can take to get control of your financial future.
-
Tax Diversification: Smart Ways to Preserve Your Nest EggA long and active retirement may be costly — and may even bump you into a higher tax bracket. Paying some taxes on your savings now could be the answer.
