Apr 18, 2024
For sheer value to everyday retirement savers, it’s hard to beat the Roth IRA. Created in 1997, this tax-advantaged investment – whose signature benefit is that it allows contributors to withdraw their money in retirement tax-free – has plenty of influential fans, especially those who don’t want a "joint account with Uncle Sam."
Among them is the irascible IRA expert and bestselling author Ed Slott, who appeared on a recent episode of "Jill on Money" hosted by Jill Schlesinger and flatly declared Roth IRAs are the best investment instruments available to savers: “Everybody knows the Roth IRA is the single greatest account to own. The only question is how much are you willing to pay for it?”
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The question is important because it underlines the key difference between Roth retirement accounts and traditional retirement accounts. With Roth 401(k)s and IRAs, you pay first by investing with after-tax dollars. Investments in traditional 401(k) and IRA accounts are made pre-tax, with taxes paid later on withdrawals – at a rate that’s hard to predict.
According to Slott, "tax-free is always better." He is a big believer in the certainty of tax-free withdrawals. What he doesn’t like is the uncertainty of future tax rates that await retirees, and he especially laments investors who confuse “tax-free” with “tax-deferred” – likening the tax hit on deferred accounts to what happens when he orders a shrimp cocktail while dining out with family.
“They only give you, like, three shrimp,” Slott explained. “If I give one away, that’s a 33% loss. I tell them, ‘Get your own.’ I'm not a sharer.”
He also rejected the popular argument against Roth IRAs that in retirement people can expect to be in a lower income tax bracket.
"That never happens," he said. " For the people who say I'll be in a lower bracket in retirement, and I'm not converting now [from a traditional IRA to a Roth IRA], that means you're letting this debt grow and it doesn't go away. At 73 — that's the new required minimum distribution (RMD) age — it could be if you let it grow enough your RMDs will exceed the income you had."
Roth IRA superpowers
Research by the Investment Company Institute showed that less than a quarter of U.S. households owned a Roth IRA in mid-2023 — meaning a lot of folks are missing out.
Roth IRAs are especially powerful because their tax-free withdrawal feature covers both contributions and earnings, provided certain conditions are met such as reaching age 59½ and holding the account for at least five years.
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And unlike traditional IRAs, Roth IRAs don’t impose required minimum distributions (RMDs) during the account holder's lifetime, allowing for greater control over retirement withdrawals and potential tax planning opportunities. Additionally, contributions to Roth IRAs can be withdrawn penalty-free at any time, which could help individuals seeking both retirement security and financial flexibility.
Roth IRAs also offer the potential for long-term growth, as investments within the account can compound over time without the drag of annual taxation on gains. This tax-free growth can significantly enhance retirement savings, especially for individuals with longer investment horizons.
But there are options, whether Slott likes them or not.
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Roth alternatives
Traditional IRAs operate similarly to Roth IRAs in terms of investment options and potential returns but differ in their tax treatment. Contributions to traditional IRAs are typically tax-deductible, reducing taxable income in the year of contribution, but withdrawals during retirement are subject to income tax. This structure can benefit individuals in higher tax brackets who anticipate being in a lower tax bracket during retirement.
Employer-sponsored retirement plans such as 401(k)s and 403(b)s often feature employer-matching contributions and higher contribution limits compared to Roth IRAs. In 2024, individuals under the age of 50 can contribute up to $23,000 annually to their 401(k) accounts, while those aged 50 and older can make catch-up contributions of an additional $7,500. The annual contribution limit for Roth IRAs is $7,000 for individuals under 50 and $8,000 for those aged 50 and older.
Remember, you can stack retirement portfolios with employer-sponsored 401(k) plans and Roth IRAs. While Slott might scoff at the tax consequence of the 401(k), the employer match can help blunt the tax bill. Holding a tax-free Roth IRA as a secondary, complementary vehicle can also soften the tax consequence of 401(k) withdrawals.
Health savings accounts (HSAs) also present an intriguing option, particularly for individuals enrolled in high-deductible health plans. Contributions to HSAs are tax-deductible, grow tax-free, and withdrawals for qualified medical expenses are tax-free.
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Chris Clark is a Kansas City–based freelance contributor for Moneywise, where he writes about the real financial choices facing everyday Americans—from saving for retirement to navigating housing and debt.
