Are Roth IRAs Really This Bad?

 Daniel: What's up, guys. Hope you're having a great day. I received an email from a friend of ours and I believe a listener to the podcast, that I felt like I really needed to talk through. And so, the article, uh, it was from life and my finances. I think it's a personal finance blog. and it's about why the Roth IRA is bad. the exact title for it is why a Roth IRA is a bad idea. Yes, you could lose money. And then the subtitle is I lost nearly 400, 000 to a Roth IRA. It's not just me. Based on our survey, the average person is losing 163, 000. So that's the article. a friend of ours, if you're listening, Lori, thanks for sending the article. Lori sent the article our way and, I immediately was like, what in the world? I need to pull this thing apart. So, that's what I'm going to do today. I'm going to talk through, what this article is talking about and, um, How it applies to most of you guys, and why it's a, a terrible article for, for you guys to, apply. one of the main reasons I wanted to talk about it as well, so the article was on this blog, which is cool. I mean, it's, they have an audience. I don't know who their audience is. So it's hard to, I mean, maybe their audience might be better suited to hear this kind of thing. But I just don't know that, but what caught my attention, so it was, it was on this person's blog. I think it also got republished on like some larger finance website. I don't remember what it is But then what caught my attention is it was sent out on a Doximity Email list. So maybe some of you listen and saw it. so like pretty much a physician population, or at least I think Doximity is mostly at least medical professionals, population and, and for that audience, it's completely terrible. so we're going to talk through that. And that's why I wanted to talk about it. It's because they're apparently blasting out stuff like this. to some of you guys and it's bad advice. so yeah, we're going to go through that. Um, I thought I'd start out with kind of summarizing the article. Um, it's a pretty long article, but, I'll kind of hit the high points. so the author is talking about his specific situation and he claims that he lost. nearly 400, 000 to a Roth IRA. as I already said in the subtitle and also claims that they've done some surveys and the average person in the survey is losing 160, 000. So he also claims nearly everyone says the Roth is a great investment in and they're all wrong. and he says that his, of his survey respondents, 92 percent of them said that they should be doing a Roth IRA, but based on his assumptions or calculations, which I'm not clear on, he believes that only 0. 2 percent should actually be doing that. So basically, like, nobody should be doing a Roth is kind of his conclusion from this article. Extremely rare situations, and it's kind of just like a waste of money. So, he does give a little bit of hope, I guess, or, he does open a slight window for potential Roth making sense in the middle of the article. The characteristics he explains that are good would be you can contribute more than 5, 000 per year and you plan to withdraw over 100, 000 a year in retirement. and I mean, I know that's a lot of you guys, but it's, that's a really unclear statement. And it, the math in this article is a little bit wonky as well. So I'll, I'll talk about that in a second. but then he goes on to say like actually Roth. So. If it's good for less than 1 percent of the population, or less than even, half a percent of the population, what he claims is that means it's good, for the government for people to do Roth IRA. So, uh, because they get more taxes and they get it sooner. I mean, if you're reading the article, I mean, it makes sense, like what he's saying. He's just It's skewed a way that I was not comfortable with. he goes on to explain the differences between the two, um, Roth and traditional. hopefully you guys know that already. If not, Roth is like tax me now and then tax free when you withdraw it. And then traditional, if your income is low enough, is pre tax now. So you save tax. now, but then when you take it out, it's taxed then. or with a 401k traditional 401k is avoid tax now, but pay tax when you take it out versus Roth 401k is, pay tax now. And then it's tax. Free or avoiding tax when it comes out, so he explains how those work and his explanation is good But where he goes wrong is He says it in order to calculate it. It's all about comparing the marginal rate now Versus the average rate in retirement and that's not the right way to look at it. I'll circle back to that as well, but He talks about how most people will earn less in retirement mainly because they haven't saved enough. I think that was the main reason he gave. Which is, you know, that's probably true. A lot of this stuff is based on averages. and it's kind of like cherry picked. But, if you're assuming we're talking about the average American, yeah, it's probably gonna be that, income is going to be, and then even the tax rates in retirement are going to be lower than they are while, while they're working. so, I mean, like I said, the parts of this article are correct. Not actually, there are some places that where it's blatantly incorrect, but the bulk of like the math and the technical components are correct. But it's just. Spun up in a way that's just generally bad for, for physicians. So, he finally starts to talk about some of the math. if you've gotten this far, you'll see, he's, he's using a, as the, in the example he's using, and this gives you a picture an indication of who the type of people he's talking about. So he uses the example of 47, 000 of annual income in retirement. And that apparently is the average income for retirees. Um, I'm not sure of the source there, but that doesn't sound that out of the ordinary. And it's mostly, according to his calculation, it's mostly coming from social security with a little bit of retirement income that's taxable. so in this example scenario that he shares, he assumes that the Roth for this person, hypothetical person, he assumes they were in the 12 percent tax bracket when they saved into the Roth. So in other words, they had to pay 12 percent tax. On the money that went into the Roth. And then he assumes that by using the Roth in this retirement scenario, they would have saved 4. 2 percent on the backend by avoiding paying additional tax in that hypothetical scenario. So, the 12 percent is just kind of a assumption of, what they're making, which that sounds reasonable for this income scenario, but the 4. 2 percent he's using the average tax rate of this situation that he created, and that. Is the correct percentage for the average tax rate, but that's not what happens. Like you use marginal taxes, when you're comparing the tax savings, like in marginal taxes is different than average. Average taxes are like take total taxes you paid divided by income. That's average. Marginal is like if you do a dollar more of income. What's the rate on that? And because we have a progressive tax, system, the marginal rate gets progressively higher the more income you make. So that's important to differentiate the two of those because when we're talking about the decision between Roth and traditional, you really should be looking at that marginal impact of the decision now and in retirement and average taxes are irrelevant. Like it's not, it's the apples and oranges comparison. Also, what's interesting about the calculation is if you technically use the numbers he's using, it really actually would be 0 percent tax because there's no tax on social security at that income level. so technically 0 percent would be the average tax rate. And the marginal tax rate in this unique, well, unique for you guys, I think, um, scenario. and in that case, yeah, like if it's 0%, well, first of all, his math was 4. 2%, but let's use the actual rate. It would be 0 percent in this scenario. If we did the calculation correctly, in that scenario, yeah, the Roth IRA. is a bad deal. and traditional makes much better sense because you, you know, you can save 12 percent and then when you take it out, you're going to be 0 percent tax rate. like I said, it's a cherry pick scenario. Like, for example, the families we work with, like this scenario is never a consideration. I mean, it's never been really a consideration. I'll talk about that more in a second. But it's a not applicable situation, I think, for most of you guys listening. So, however, he uses this to, I think this is what he uses. It's like I said, some of the math is unclear, but I think that's, this is the calculation he uses to kind of base this. idea that his surveyed people would have lost 163, 000, maybe, I'm not sure it's unclear. he also concludes that 100 percent of those surveyed would have been worse off investing in a Roth IRA. so that's a pretty big claim, and it sounds like he surveyed a lot of people. So, I've already talked about some of the problems. it's misleading. I think the first problem, the problem that was most concerning for me, it's like if you just look at the headline and a lot of people like glance at headlines. you just look at the headline of this thing, it's like 400, 000 cost of Roth IRA investing. So he uses the word like, I lost, that's like past tense. It's like, he's saying I lost, and this is, it appears this guy's pretty young. So it, and that would imply, it would be easy to assume that he's talking about the value of the account went down. Like as in, The investments themselves, which you could quit. You could, if you're just glancing at it, you're like, huh, so that this person saying that Roth IRAs are terrible investments. In other words, the investments that you get with a Roth IRA cost you a bunch of money cause they're terrible. And that's completely not what he's saying. Like he's using the taxes to kind of, I think he's using his, the tax scenarios we've just kind of gone through to justify this. But, it would be easy to assume especially after a quick glance that he, he actually is talking about the investment, returns and that's super misleading. I don't, I don't know, I'm going to have to assume he was not intentionally trying to do that, but, I think it's an unintended, assumingly unintended consequence of it. And that was the first thing I thought when I saw it, I'm like, how are they coming up with that? And so just to clarify that point. The Roth IRA really doesn't have anything to do with the investment performance aside from the tax difference. So like if we're comparing a Roth to another IRA, like a traditional or, or whatever type of investment you can, they're just like, uh, the vehicle you hold the investments in, like you can hold all sorts of investments in any of those different vehicles. And so the only thing that affects the performance. Assuming you're holding the same investments in all of them, which should be entirely possible. the only difference between them. Will really be taxes and so that's misleading because of that because it kind of makes you think maybe that there was some bad investments that were directly connected to what Roth IRAs offer. and so if you read on, you'll start to see him talk about taxes and that's, what it really comes down to. So the 400, 000 is coming from taxes, but the other problem about it is, like I said, he's using past tense. but his assumptions are based on future taxes. So that's misleading as well. It's like, I lost 400, 000. No, no, no. He's assuming he will probably lose 400, 000 based on all these assumptions that I've kind of started to, to mention and, I do not think apply to your situation. And I don't, it's, it's difficult to, see what even calculations he's using. so it's like cherry pick data, really a big lean towards fear based, uh, language. There's a lot of lack of clarity. that's partly why I've gotten a lot more hesitant to show calculations in content we create. It's difficult to, understand where they're coming from when you show calculations, without providing like lots of explanation and sources and details. Like just for example, how is he defining income technically? Like when he shows average income, like technically is that taxable income? Is that, Earned income, like, is this adjusted gross income? There's lots of different, technically, there's lots of different ways to define income. how is the math, how are we calculating 400, 000 for his lost Roth IRA? I, that's completely unclear. so I think the gist of this is that I think I would agree that probably like the average American is better off doing Or not doing a Roth because they kind of have a choice and uh, they're probably not saving enough and. The concepts he's talking about probably make sense, I don't know about 99 percent, but like definitely not 99 percent. But if we're strictly talking about the average American, the majority of them probably are better off leaning towards doing a traditional IRA and not doing a Roth IRA. But for you guys, it's like I've said, it's completely different. So, so let's start to start to talk about how this applies to physicians. so first of all, most of you guys, I know, especially in practice, you're going to be maxing out your work retirement plans. So like 401ks, 403bs, that kind of thing. And when you have maxed out those tax shelters you know, that that's kind of like the buckets full, then it's like, okay, well, what's my next option? And really the, only really good alternative beyond that is to do like a backdoor Roth IRA and you can't even fund it. Well, you can fund a traditional IRA, but if you're, if you're at the average physician income level, you won't be able to get the tax deduction on it. So in other words, like benefit now doesn't apply, which kind of kills the benefit of the traditional IRA. So the Roth IRA is really like the next really good tax shelter beyond or after maxing out work retirement plans. And in that situation, when you're looking at the Roth IRA, you really should be comparing it not to a pre tax alternative, but to Like a taxable investment or the non deductible IRA, which never is going to make sense. So, in a taxable investment and a non deductible IRA, when we compare those to the Roth IRA, the Roth IRA will always be better. Like it's without a doubt avoiding tax. Um, is going to be better than paying some tax on after tax dollars. So that's an easy decision when you've maxed out all your work plans and there's no options left through work using that backdoor Roth IRA is going to be a best going to be a really good move because it's, we don't have as many options in that situation. on top of that, most of you guys, so going, going back to his scenarios in retirement. Most of you guys are going to have multiple streams of income in retirement. So that makes it a lot more complex. Social security starts to get taxed as you make higher income. That's not considered in this example. and when you have all these streams of income, I mean, at the minimum, it just makes it a lot more complicated. but. It can quickly swing the pendulum the other direction. the other thing about his article, I F I forgot to mention this, like one problem with this, if you just read this article and you're like, I'm a physician, Roth IRAs or Roth 401ks are bad. Okay. I need to do all traditional, which is kind of what the article. It's definitely with the article advocates, by doing that, you're actually like building up a bigger bucket of future to be taxed money or like another way of looking at it. It's like uncle Sam's got a share of that bucket of money you're building up. And the bigger you build that bucket up, the more your tax burden is going to be in retirement. So it's like the further along you go with this strategy. It ends up backfiring on you and causing, it can quickly swing back to where your retirement tax rates actually end up equal or even higher than your work year tax rates. so here are some, a little bit more specific examples that would apply to you guys. I think the best way to do it is to personalize it to your situation. That's always the best way to do it. That's why these articles are oftentimes. Bad, because they're generalized. sometimes there's errors in them. and they're definitely not personalized to your situation. we can throw out some like general scenarios that'll likely you guys will go through at times in your life. The best one I think is like in training. especially in training, but even like, it could be like an in, lower income year. Like say you Retire early and you have a part, maybe you're working part time at a much reduced income level. those two scenarios, like in training especially, you're probably going to be in the 10 or 12 percent marginal. tax rate. And so that's, that's really low for a physician. and the average physician we work with their retirement marginal rate is going to be higher than that. and I'm talking about averages and sometimes way higher than that. And so the Roth IRA is. Or the Roth 401k even. Anything Roth is extremely likely to be the best option, because it's going to be really good if you could pay that 10 or 12%, as opposed to when you take it out, paying like 20, 30, sometimes close to 40%, on the backend. On the flip side, if you're like very high income, like you're at your kind of peak earning years, and especially if you're in like the highest tax brackets, like say you're in the 35 percent rate or 37 percent marginal tax rate, in that case, not always, but like most of the time in that case, the traditional 401k, not the traditional IRA, Because you can't do that, you can't deduct that at that income level. But the traditional 401k, like the pre tax 401k or 403b, is likely much better than the Roth 401k or 403b. now it's still good to do the backdoor Roth IRA. but in that situation, when you have the choice, like as in the 401k, you can either do traditional or Roth. It's, it's, it's very likely that the pre tax option, the traditional 401k is going to be much better because you're at that high 35 percent plus, uh, tax rate. Um, and so you might as well get that benefit. Now there, the exception to that sometimes happens if you're like a, Super saver, like huge. especially if you're like going for financial independence early and you're a big saver and you're likely to continue, working beyond financial independence. What happens in that situation is you can sometimes create like a kind of a time bomb of like. Future taxes, like the more you defer all these things, it creeps up and, you know, the more, the longer you work, it delays it as well. So you can, it can compound to where you're going to have a high tax bracket, no matter what. So that's kind of a different situation. now most of you though, are probably going to be somewhere in the middle of those two extremes I just talked about. and really all of you, it goes back to, your own personal planning. That's the ideal way to do it. You need to look at, like, your circumstances, your, even your preferences, really, like, your tax situation now, your income situation now, what options you have available, and then trying to get a good idea of projections for the future, and comparing, making sure to compare marginal rates, when you're doing that, like the article did, or unlike the article, the article was Trying to say you should compare average tax rates in retirement. So, you really, you have to look at marginal rates now, and compare those to marginal rates when you are likely to be withdrawing it. And that, that's the best, uh, and most helpful way to decide between Roth versus traditional. When you have that choice and it's, it's actually the one thing this article did get right is, I mean, he didn't exactly say it how I would say it, but, um, it is pretty simple when you do the math on it and you're comparing the two. It's all about like, what's the rate now? Marginal. And what's the rate at withdraw? Marginal. Where he went wrong is he said average tax rate, but, it's actually pretty simple. You just have to look at the marginal rate now. When you're putting it in if you're in that really high tax bracket and compare it to likely Marginal rate in retirement and say you're in a lower tax bracket Compare the two of those if you're higher now Then the pre tax is gonna be a better route versus if you're lower now And you expect it to be equal or higher the Roth is gonna be the better so So I appreciate you guys sharing articles like this if you see others, please send them my way You got to be careful what you read about on Online. I'm sure you guys know that already as with money or really anything. It's, it's kind of like medicine, general advice, not, not applied to your personal situation that can be super dangerous and can cause more harm than good. The devil's in the details. So you gotta really kind of be cautious about buying into these things. So please share those sorts of articles you come across in the future or questions that you have, and we'll would love to cover those in the future. We'll catch up with you next time.