At What Age Does a Roth IRA not Make Sense?
The value of Roth IRAs certainly ebbs and flows throughout one’s investing life based on a number of factors like income, age, and other retirement savings. However, Roth savings always have the potential to provide value to virtually any portfolio. There is not an age at which Roth IRAs cease to make sense.
If you’ve read many of my posts, you know I’m a big fan of Roth IRAs. They are an especially useful tool if you’re in a lower income tax bracket (like 12% or less).
Roths potentially benefit families and investors with lower incomes the most since they can lock in their tax liability at the time of contribution and allow their accounts to grow completely tax-free.
Additionally, contributions to Roth IRAs can always be withdrawn without penalty which removes one of the significant emotional barriers one might have with a Traditional IRA.
If any objection is raised against funding a Roth IRA, the basis is almost always higher income.
In fact, Roth IRAs do lose their luster as one’s marginal tax bracket increases because it doesn’t exactly make sense to pay income tax on a contribution if there’s a good chance the withdrawal will be made at a lower rate.
We won’t get into the Roth vs Traditional debate in this post, but it is certainly worthwhile to evaluate the decision yourself.
Higher income aside, are there other circumstances that make Roth IRAs less attractive than their tax-deferred counterparts?
In particular, are there times when the decision to utilize a Roth IRA might weigh more heavily upon one’s age or working situation than their income?
Let’s dig into these ideas a bit and find out.
Who can contribute to a Roth IRA?
To begin, let’s revisit the eligibility requirements for contributing to a Roth IRA.
First, you need earned income. You cannot contribute to an IRA of any sort in a tax year in which you receive no earned income.
This is really too bad for you parents out there who’d like to get a head start on your kid’s retirement savings. After all, one dollar invested today will be worth $159.04 in 50 years.
That means fully funding a Roth IRA with $6,500 (the contribution limit in 2023) just once now would be worth $1,033,760 in 50 years.
Alas, the kiddos have to have earned income from a j-o-b before anything can be contributed in their name.
Furthermore, only an amount equal to one’s total earned income or $6,500, whichever is less, can be contributed in a given year.
The only exception to this rule is for a non-working spouse who can contribute to an IRA based on their working spouse’s earned income if the couple submits their taxes as married, filing jointly.
After you have earned income, the next step is not having too much of it.
In 2023, eligibility for Roth IRA contributions begins to phase out if your modified adjusted gross income (MAGI) reaches $218,000 (married filing jointly) or $138,000 (single).
Once your MAGI reaches $228,000 (married filing jointly) or $153,000 (single) you will not be able to contribute anything.
So, at what age does the IRS stop letting us contribute to a Roth IRA?
There isn’t one. Contribution eligibility is completely tied to income. That’s it.
Assuming You Can Contribute, Can You Be Too Old?
So, since we know age alone doesn’t disqualify one from contributing to a Roth IRA, is there a point in life when it doesn’t make sense?
The answer is…it depends.
One of the most attractive aspects of a Roth IRA is tax-free growth. And the earlier you can get your assets to work on building that tax-free growth, the better.
The inverse of that is also true. The less time your investments have to grow before being withdrawn, the less valuable those contributions are.
So, let’s spitball this a bit, shall we?
Let’s assume Mr. Counting Dem Days is 60 years old and plans to retire at age 65. Mr. Days wants to continue taking advantage of the tax benefits associated with IRA contributions but isn’t sure if he should go with the Roth or the Traditional option.
Here are some possible scenarios and things to consider for each one.
Scenario 1: Mr. Days Will Be in a Lower Tax Bracket in Five Years
In this case, the choice is a no-brainer. Mr. Days should contribute to a Traditional IRA instead of a Roth because this will allow him to pay income tax at the time of withdrawal which will be at a lower rate than it is today.
Scenario 2: Mr. Days Will Be in the Same Tax Bracket in Five Years
Mathematically, it may not matter, but it probably does. If tax rates are equal at the time of contribution and withdrawal, then the account balance after taxes will be exactly the same.
Feel free to run through a calculation yourself if you need convincing, but it’s true.
But that doesn’t mean it doesn’t matter.
In my opinion, Mr. Days would probably benefit more from contributing to a Traditional IRA because deductions for contributions to a Traditional IRA are taken at one’s marginal tax rate (what I call the “top” of your tax bracket) while withdrawals will probably be made beginning at one’s lowest income tax rate in retirement (the “bottom” brackets).
The reason this is probable is because Mr. Days probably won’t have any earned income when he retires.
No earned income means no income taxes on earned income. As a result, other income sources like IRAs will be the first sources used to calculate his adjusted gross income.
And since we have a progressive tax system, the first dollars of income are taxed lower than the last ones we earn.
How much of a difference could this make? Well, the dollars up to one’s standard deduction or itemized deductions will basically be tax-free. Then the brackets range (10%, 12%, 22%, 24%, 32%, 35%, and 37%), so it could save you anywhere from 2% to over 20%.
Scenario 3: Mr. Days Will Be in the Same Tax Bracket in Five Years, but Has a Monster Traditional IRA/401(k) Balance
In this case, Mr. Days should evaluate the merits of using a Roth IRA.
Why? Because that monster Traditional IRA or 401(k) balance is going to lead to hefty required minimum distributions (RMDs) when he reaches that age (75 for most of us).
RMDs are money the government forces one to remove from their tax-deferred savings vehicles so the balances can begin to be taxed.
It prevents us from having income completely sheltered from income tax forever.
It also means you will eventually lose control over ‘when’ you take money out of these accounts, whether you need it or not.
It would be worthwhile for Mr. Days to consider taking advantage of whatever Roth benefits he can get, such as they are.
Scenario 4: Mr. Days Will Be in a Higher Tax Bracket in Five Years
In this scenario, it gets harder to make a case for using a Traditional IRA, even with the short runway to retirement.
But it still depends.
The only reason I can think of that Mr. Days will have more income in 5 years is because he wants to pull a lot of money out of his qualified (tax-deferred) retirement savings.
After all, if he’s retired at 65, he won’t be receiving that extra income from an increased salary.
And if he’s choosing to realize more income, then I also assume he has a significant balance to withdraw from.
In this case, I’d go with the Roth because RMDs will likely also be significant in this scenario and I imagine Mr. Days would be interested in getting as much of my money into a Roth account as possible before that happens.
With all of that said, this could change based on how vast the difference between tax brackets will be, how much money Mr. Days actually has, and what other sources of income he will receive in retirement (like pensions and social security).
A Note About Flexibility
One should also consider whether or not tax efficiency is the primary factor in making a choice between Roth and Traditional IRAs at this later life stage.
Yes, it’s always nice to save a few bucks here and there on taxes, but flexibility through asset location is also an exceptionally valuable tool in managing income taxes in retirement.
If all of your retirement assets are in a Traditional Account, then your options are pretty limited. Having a large portion of your assets in tax-deferred accounts also means you could face high taxes due to RMDs one day.
You may save more in the long run by having a healthy variety of buckets to choose from when you begin making withdrawals.
In summary, don’t overlook the value of having options.
Assuming You Can’t Contribute, Are There Other Ways to Fund a Roth IRA?
So far we’ve only considered how one might utilize a Roth IRA if they are eligible to contribute.
But you can also use Roth IRAs through IRA Conversions if you are not eligible to make direct contributions, regardless of whether or not you have any earned income.
We won’t go into great depth here, but if you’d like some thorough examples I encourage you to click the link above.
In summary, once you retire and no longer have any earned income, it might make sense to convert some of your Traditional IRA funds (which will one day trigger RMDs) to a Roth IRA.
If you do this, the converted amounts will be subject to income tax, but the idea is you’ll be taking the tax hit at a lower bracket than you would have when you were working or when RMDs begin to make their mark.
This requires some cash on hand to pay Uncle Sam his share and you will need to do some planning in advance to maximize the efficiency of this strategy, but it will probably be worth it.
Why You Should Try To Focus on Roth Even in Retirement
Finally, I want to impress upon you the immense value of Roth IRA funds in retirement.
Roth dollars are the only dollars you can posses in retirement that are completely under your control.
HSA dollars have to be used for medical expenses to be completely tax free and any balance you leave to your heirs will be completely taxable in the year of your death.
All tax-deferred funds are subject to tax upon withdrawal and you, your heirs, or probably both of you will be forced to remove those funds at some point so they can be taxed.
When considering the most efficient way to make withdrawals from retirement accounts, financial advisors typically recommend that you touch your Roth accounts last.
There are no RMDs, no taxes, and your heirs get anything you leave completely tax free too.
What’s not to love?
Conclusion
So, at what age does a Roth IRA not make sense?
I don’t think there is one.
There may be times when contributions are not ideal from a tax efficiency standpoint, but having money available in a Roth account will always have value.
