The Disadvantages of Tax Advantage Retirement Plans

We’ve talked about what a Roth IRA is along with a handful of its advantages but how about the disadvantages? Despite being a fairly complicated Individual Retirement Arrangement that can be invested into along side your 401(k) plan, for those of us who are lacking in financial awareness, it’s an important retirement option that invests heavily in securities, common stocks and bonds typically through mutual funds (other options such as real estate and derivatives are available). With tax free withdraws and tax-advantage transactions made within the account avoiding current tax liability, it’s a popular plan. Now, on to those disadvantages!

While we’re always happy to hear about a tax free system, this also means that those who are investing in a traditional IRA account receive an immediate tax savings equivalent to the amount of their contribution which is multiplied by their marginal tax rate (income based). You might already be familiar with this thanks to your employer sponsored 401(k) retirement plan which are tax deductible without any income limitations thanks to the reduction to your adjusted gross income. Most of us know the importance of reducing your adjusted gross income lies in the fact that you can more easily qualify for tax credits assuming your income is on a threshold that may otherwise prevent you from receiving those. Contributing to a Roth account does not help reduce this.

This means that choosing to contribute to your Roth account means you’re choosing to pay income taxes at your current rate – something, I think, we can all agree is not necessarily a good thing. Who doesn’t want to pay lower taxes? Let’s say that Congress decides to get together and lower income tax rates or you retire and find yourself in a lower tax bracket because of your taxable income has diminished; you might find yourself paying more in taxes on your earnings used to make your Roth contributions! The factors that could go into this are clearly a complex issue and not one you’ll find likely discussed on this blog.