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Where did the idea for a "piggy" bank even come from? Seems strange to me.
Individual retirement accounts (IRAs) can come in several shapes and sizes. Among the most popular, however, is the Roth IRA. Introduced in 1997, the Roth is a special tax-advantaged account funded with after-tax dollars. Those dollars may then grow tax-free for the duration of the account, and remain tax-free when you begin making withdrawals during retirement. This can be a huge advantage when saving for the future. So why don't I fund mine?
Why I Don't Fund a Roth IRA
First, let's explain your other main option - the Traditional IRA. Unlike the Roth, the Traditional is funded with pre-tax dollars, but tax is then due on all earnings and on withdrawals. The typical conversation with a retirement broker may go something like this:
Broker: Do you think taxes are likely to be higher now or in retirement?
Me: (thinking) They probably will be higher in retirement I guess. It seems like I've heard something about interest rates being lower and the feds are increasing, which probably has something to do with taxes. I don't really know, but this Broker guy seems like he knows more than me so... (speaking confidently) Probably in retirement.
Broker: Then it makes sense to pay the taxes now when they are low, doesn't it?
Me: Yes, that definitely makes sense!
This is...okay advice, if not a bit leading. If you are among the general population, you can do a whole lot worse than investing in the Roth IRA. In fact, if you are making below around $30-35k, you probably should fund the Roth IRA. I'll get back to that in a minute.
If you are making more than this amount though, there is a strong argument for investing into a tax-deferred account such as the traditional IRA. Here's why. Let's say you command a salary of $100,000 annually. Even with employer retirement funding, HSA funding, and other considerations, you are likely to fall within the 25-28% tax brackets. In fact, you will need to make nearly double that salary ($191,650 in 2018) to move into the next bracket. So how exactly are you likely to pay more taxes in retirement given these numbers? Do you plan to need almost $200,000 per year to live? I most certainly will not.
There's another option - the backdoor Roth IRA. Here's how it works:
By employing the backdoor Roth method, it is possible to delay taxes in your high-earning years and "pay" those taxes at 0% in retirement. Even if you move over more than what is covered by the standard deduction, you are still likely to pay a very low effective rate. This is far better than paying those taxes at 25-28% as you would have.
As much as I would love to claim credit for this plan, it does not originate with me. Do your future self a favor, and read through the Mad Fientist's article on the subject a few (dozen) times. This is one of my favorite articles, and it has completely changed my outlook on retirement.
So what do you think? Is this a reasonable plan or am I as crazy as a Mad Fientist? Let me know below!