How much do you really know about Roth IRAs?
Posted by: Ted on Feb 26, 2016 in News | No Comments
Having been a tax practitioner and financial advisor for quite a while now, I am still scratching my head, trying to understand what the allure is of this investment vehicle. I’m still drawing a blank.
I often receive questions about investing in these tax-sheltered vehicles but more often than not I receive information at tax time when the client has already made the decision to make the investment.
From a tax perspective this is important because in most cases people are making contributions that they are not allowed to make based on the IRS limitations for both traditional and Roth IRAs. An unqualified contribution can be reclassified and subject to a 6% excise tax.
But that’s just compliance. Why do I think they’re inappropriate and inefficient investments? Let’s first start with why the Roth was created. To find the answer you have to understand what the motivation is for congress to offer this type of product to the public through large institutional banks and brokerage firms. It should come as no surprise to you that congress has been growing our deficit for decades, meaning tax revenues are not keeping up with tax expenditures (offering tax sheltered investments as an example) and to cover the gap it has to print money.
This has been the case since the economic meltdown in 2008. Through the governments intervention to save banks that are too big to fail we now have the Federal Reserve artificially keeping rates low so banks are able to recapitalize their balance sheets and recover from near collapse. The Federal Reserve is also making sure rates are low because as the deficit keeps growing the interest on the increasing obligation continues to grow as well, deepening the already large crater in the US deficit.
Contrary to popular opinion that the government always operates for the common good of the people, in this case, the government chose a financial strategy to slow down the expenditures on tax sheltered vehicles like a traditional IRAs and deployed the new Roth IRA so that it does not give up anymore tax revenue.
In effect, the government is trying to dissuade you from making tax deductible contributions that would benefit you today but do not benefit the government. Now we’re seeing new products offering corporate Roth IRAs that allow you to contribute to the Roth IRA versus a 401k giving the government the relief it needs while penalizing you for saving and making you feel you’re doing something right.
The only entities Roth IRAs help are the government and large financial institutions packaging new products to peddle to you. The government doesn’t lose any revenue on your contribution to a Roth and large investment institutions continue to market these vehicles as sound retirement alternatives. They know your hands are tied until you reach age 59 ½. What a wonderful continuous revenue stream for both while exposing you to unknown market risk for decades.
At the same time while we sacrifice our investment dollars making these contributions year after year we just accept living in perpetual debt while financing the US government and big banks. Does that make sense to you?
From the value perspective, what exactly is so interesting in investing in a Roth IRA? First, and most important, you cannot get a tax break on the contribution! Then you have income limitations and if you don’t qualify but still make incorrect contributions you can be subject to a 6% excise tax. Third, you cannot take your money out in an IRA until you’re 59 ½ without paying a 10% penalty and in a Roth while you can take out your principal, any profit would be subject to the 10% penalty as well. The so-called big ‘benefit’ in the Roth is that you are not required to take minimum distributions at age 70 ½. So that’s the big benefit? Who the knows if we’ll even be around at that age let alone worry about paying a small amount of tax by taking a distribution at a time when we’ll probably need it anyway before age 70 ½?
So in a nutshell, we’re scrambling to save and entangle our money in government sponsored vehicles that yield us zero benefit today, for the hope that we’ll live to age 70 ½ and be so wealthy that we won’t need to take a distribution out of our IRAs. Doesn’t sound very realistic for most of us.
I’m not even going to get started on your investment limitations and choices depending on your investment provider. Usually you’re stuck with a small amount of funds to choose from or index funds of some sort. Let’s consider what the market has been doing in just the last month. It tanked! And to those of you patiently waiting and sitting on the sidelines in 2015, you were able to buy up so many wonderful companies on an individual basis, at a discount, and continue to dollar cost average – job well done.
So what are you supposed to do? How are you supposed to plan for the future, your retirement and the security of your family? Aren’t there more efficient ways to invest and deploy your money? There are indeed.
I’d be happy to share my thoughts and ideas with you. It starts with setting priorities and realizing your earning potential has limits so you have to be extremely careful with how you deploy your hard earned dollars. Do you trust the government or large financial interests to help you?
For starters, trust in yourself, know your limits, reduce your debt, hedge against inflation (rents) by buying an affordable home, protect your income and family and invest the difference in high quality, important companies that pay dividends.
There are time-tested, proven strategies for building wealth with minimal risk.
Let’s start the conversation.