You'll often hear that the Roth IRA is the best retirement savings plan out there, and there are plenty of good reasons to fund one. But Roth IRAs have their drawbacks, and so before you open one, be aware of these pitfalls you might encounter.
1. Your tax rate could go down in the future
When you contribute money to a Roth IRA, you don't get an immediate tax break. Rather, your tax savings arrive during retirement, when you're entitled to withdrawals that aren't subject to taxes. Savers are often encouraged to choose a Roth IRA if they feel their tax rate will rise during retirement. That way, they pay taxes on their money at a lower rate and then enjoy tax-free withdrawals when they're subject to a higher one.
But what if your tax rate doesn't end up being higher in retirement? What if tax reform slashes rates across the board, or your personal circumstances put you in a lower tax bracket as a senior than you're in now? In that case, you lose the tax benefit that may have inspired you to save in a Roth IRA in the first place.
2. You could end up needing to take annual retirement withdrawals
The Roth IRA is the only tax-advantaged retirement plan that does not impose required minimum distributions, or RMDs. RMDs can be a hassle in traditional retirement plans because they create a tax liability, but even for Roth 401(k) savers, they can still be a nuisance -- namely because in removing funds from your account, you lose the opportunity to continue enjoying tax-free investment growth on your money. Many people therefore favor the Roth IRA because they won't be compelled to deplete their accounts before they're ready.
But what if you end up needing large chunks of cash from your Roth IRA? Suddenly, you're taking distributions and losing out on that tax-advantaged growth anyway, thereby negating one major Roth IRA benefit.
3. The temptation to remove money before retirement could leave you short later on
Removing money from a traditional IRA before age 59 1/2 will generally result in a 10% early withdrawal penalty on the sum you remove. But with a Roth IRA, that penalty doesn't apply, provided you take withdrawals against the principal portion of your account, and not the interest portion. The reason? You 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 tempt you to take early Roth IRA withdrawals for no good reason. It's one thing to tap your retirement savings in an emergency, but the knowledge that you can dip into your principal contributions at any time could cause you to make poor choices that ultimately leave you with a shortfall heading into your senior years.
Let's be clear: There are plenty of good reasons to save for retirement in a Roth IRA. But before you make that decision, be mindful of the ways it could backfire. That way, you'll be less likely to regret your choice later in life.