By Andy Ives, CFP®, AIF®
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In my April 12 Slott Report entry (“5 Reasons to Open a Roth IRA Immediately!”), I included a handful of points as to why it was imperative to open a Roth IRA, especially before the tax filing deadline. But a coin has two sides. Here are 5 reasons why you should NOT open a Roth IRA:
1. You have no earned income. To be eligible to open a Roth IRA (or traditional IRA) with a contribution, a person must have “compensation.” Wages, salary, commissions and/or other dollars received for personal services all qualify as compensation for IRA contribution eligibility. Things that do not qualify as compensation include pension and annuity income, interest income, capital gains or Social Security benefits. No compensation equals no Roth IRA contribution. (Of course, you could still open a new Roth IRA via a Roth conversion. Roth conversions do not require one to have any compensation.)
2. You have too much earned income. At the other side of the spectrum are individuals who make too much money to contribute to a Roth IRA. The phase-out ranges for Roth IRA eligibility in 2023 are $218,000 – $228,000 for those filing married/joint, and $138,000 – $153,000 for single filers. (In 2022 the phase-outs were $204,000 – $214,000 and $129,000 – $144,000, respectively.) If your modified adjusted gross income is above these phase-out ranges, then you are prohibited from contributing directly to a Roth IRA. (Yes, a Backdoor Roth conversion could be an option, but be wary of the pro-rata rule!)
3. You need the money soon. A person always has access to his Roth IRA contributions tax-and penalty-free. But if you need the money for a big purchase soon, or if you need the money for daily living expenses, it might not make sense to go through the process of opening a Roth IRA now. This is especially true if you are under age 59 ½ and need access to any earnings that might accrue within the Roth IRA. For those who need cash now or for a big purchase at some point in the near future, a non-qualified (regular) account may be a better option. If managed properly, you will have full access to the principal as well as the earnings.
4. Your beneficiary is a charity. Charities do not pay income tax. If your goal is to leave your IRA to a charity, then definitively do NOT fund a Roth IRA. Why pay taxes on the dollars yourself and go out of your way to create a tax-free income source…for an entity that won’t pay taxes anyway? Instead, fund a traditional IRA, take the deduction if you are eligible, and in the end, no one will pay taxes on any of the IRA dollars – neither you nor the charity.
5. You just don’t trust the government to keep its tax-free promise. Yes, tax laws are effectively written in pencil, and the tax-free benefits of a Roth IRA could, theoretically, be stripped away. If you think the rules will change and tax-free earnings on Roth IRAs will be eliminated from the tax code, then you probably should avoid a Roth IRA. (A queen-size mattress might be a better option.) However, it is our opinion that Congress has tipped its hand. They love Roth IRAs! This was evident in SECURE 2.0 with all the new Roth options – Roth SEP, Roth SIMPLE, Roth employer match, etc. Roth means tax revenue now, and that is music to the ears of a politician.
Before opening a Roth IRA – think it through. It is not the perfect fit for everyone.