Stop contributing to Roth IRA?

[windytrail]

Hey all,

I am wondering whether it makes sense to stop contributing to a Roth IRA and instead put the money into my brokerage account.

Relevant factors:
- Age 31
- Married, but we file taxes separately
- Employed and covered under a 401(k) plan with employer; already maxing contributions
- Current pre-tax income is $140k + 10% bonus
- Not eligible for HSA

The benefit of a Roth IRA is tax-free growth, but the downside is not being able to access that growth until much later.

GoCurryCracker seems to look down upon Roth IRAs, but they admit this is a controversial stance:

What if you have already maxed out a 401k, an HSA, are not eligible for a deduction on a Traditional IRA, and have quite a bit of money remaining to be invested.  Isn’t putting $5,500 into a Roth better than putting those funds into a Brokerage account?

No

Because we aspire for a long retirement, our portfolio is stock heavy.  As explained in our classic post, Never Pay Taxes Again, taxes on Long Term Capital Gains and Qualified Dividends is 0% for incomes below ~$94k.

This is the same tax profile as a Roth, but with one distinct difference

We can spend those capital gains and dividends whenever we want, whereas the earnings in a Roth cannot be touched until Age 59.5 without facing a penalty and taxation (you can only access the Contributions)

Let’s look at that in numbers for Mr and Mrs 90%

Over a 13 year working career (faster due to using tax breaks of 401k), putting $5,500/year into a Roth IRA results in about $72k in contributions.  Using the FV function in Excel and a 7% annual return, when we retire early the account is worth about $110k.

If we had invested those funds in a Brokerage account instead, we would also have $110k.  Since Mr and Mrs 90% didn’t sell any of their stock they generated no capital gains.  And since they invested in their 401k reducing their marginal tax rate to 15%, they paid no tax on any of the dividends.

Of course with that stock being in a brokerage account, they have full use of the annual dividends.  At a 2% dividend rate on the S&P500, that is $2200 per year in cash flow for our use with zero tax

Fast forward 10 years, assuming the same annual growth rate, the account is now worth about $218k and continues to pay dividends (isn’t it great when the market only goes up?)  Speaking of the market going up, you can’t harvest capital loss in a Roth

Assume at this point we need access to $150k in future dollars to buy a large sailboat to fulfill our dream of sailing around the world.

If we had invested in a Roth and we try to access our Roth contributions at that point, we only have access to our original $72k investment.  We need more money

While full access to contributions is often cited as an advantage of a Roth, those contributions lose to inflation with each year.  While we can access our $72k in contributions, those funds are only worth about $53k in Jan 2015 dollars.  The earnings are much more valuable

Because we didn’t have access to the dividends in the Roth during our decade of joyful living, we’ve been spending down the Brokerage account a little faster.  Maybe we don’t have enough funds there to cover the difference

Now we need to either tap the Traditional 401k/IRA or the earnings in the Roth.  Both result in a 10% early withdrawal penalty and full tax on the withdrawal.  Such is the price of fulfilling our dreams

But what if instead we didn’t use the Roth years earlier?  We have $218k sitting there in our brokerage account, ready to use at our leisure without restriction.

And that is why the Roth is last, and why there is a big Maybe for all Roth contributions
https://www.gocurrycracker.com/roth-sucks/

GCC's reasoning is persuasive, or am I missing something?

[seattlecyclone]

The benefit of a Roth IRA is tax-free growth, but the downside is not being able to access that growth until much later.

This is the trade-off, yes.

The limitations on accessing the growth at a younger age are a good reason why you might not want to put all of your money in a Roth account in your 30s, but it's not a sufficient reason to avoid Roth accounts entirely. You'll need some money from somewhere after you turn 60; why not put enough in Roth so that the Roth growth can make up a good chunk of your withdrawals at that time?

Meanwhile the comparison saying growth in a brokerage account is tax-free (and therefore just as good as Roth) falls flat for a number of reasons.
1) Until you retire to a low enough tax bracket you'll be paying 15% federal tax on those dividends every year, meaning the balance in the account at retirement won't be equal in the brokerage vs. Roth comparison.
2) If you're planning to buy health insurance from your local ACA marketplace when you retire, you'll be taxed on the brokerage account growth then too in the form of marginally lower premium tax credits.
3) Most states will tax brokerage account growth, even if it has a 0% federal tax rate.
4) When you pass away your heirs will need to pay tax on any growth that happens in your brokerage account after you die, while they'll have ten years to let the Roth keep growing tax-free if they don't need the money right away.

As with anything else in life there are trade-offs, but I think the Roth account offers a compelling deal for a lot of people a lot of the time.

[MDM]

Relevant factors:
- Age 31
- Married, but we file taxes separately
- Employed and covered under a 401(k) plan with employer; already maxing contributions
- Current pre-tax income is $140k + 10% bonus
...
GCC's reasoning is persuasive, or am I missing something?

You don't fit GCC's profile, so his reasoning doesn't apply to you.

One other difference: when it comes time to take Social Security, Roth withdrawals do not affect Taxation of Social Security benefits but income from taxable accounts does.

You mention "stop contributing to a Roth IRA" - are you using the Backdoor Roth process?  Asking because the Roth IRA Contribution Limits are very restrictive for MFS.

[windytrail]

Thank you for your replies. They helped focus my thoughts and questions.

My biggest concern was having enough funds available in non-retirement accounts by the time I reach FIRE. Right now 58% of my funds are in retirement accounts with the remaining 42% (about $100k) in brokerage and savings.

But assuming I keep contributions the same as today ($25k into retirement accounts each year and $65k into brokerage account), and assuming 7% return each year, then in six years the balance is projected to be:
$401,000 (retirement)
$647,000 (non-retirement)
Total: $1,049,037

         Retirement   Non-retirement  Total
Today   $140,000   $100,000   $240,000
2022   $176,550   $176,550   $353,100
2023   $215,659   $258,459   $474,117
2024   $257,505   $346,101   $603,605
2025   $302,280   $439,878   $742,158
2026   $350,190   $540,219   $890,409
2027   $401,453   $647,584   $1,049,037

You don't fit GCC's profile, so his reasoning doesn't apply to you.

One other difference: when it comes time to take Social Security, Roth withdrawals do not affect Taxation of Social Security benefits but income from taxable accounts does.

You mention "stop contributing to a Roth IRA" - are you using the Backdoor Roth process?  Asking because the Roth IRA Contribution Limits are very restrictive for MFS.

Thanks for pointing that out. We are recently married and both filed as single last year. I didn't know about the $10,000 Roth income limit for MFS. Seems absurd that they would restrict this, but we may need to file jointly next year to preserve the Roth, at least for her. We were planning to do MFS because we are trying to keep our finances separate, but this makes things more complicated.

[seattlecyclone]

We were planning to do MFS because we are trying to keep our finances separate, but this makes things more complicated.

Filing separately very often results in more tax owed between the two of you, plus random things such as super-low IRA limits. Unless you're in a rare situation where filing separately is actually cheaper (student loans on income-based repayment is the main one I'm aware of), file jointly and settle up amongst yourselves for whatever split you feel is fair.

[terran]

The MFS comment also stuck out to me. Definitely worth looking closely at that.

Based on your projections you'll have more than enough outside retirement accounts when you retire since it's possible to access retirement accounts before age 59.5 with a little bit of effort.