Let me start out by stating that I don't hate Roth 401k and 403b accounts. That being said, the advice I consistently give my physician-clients is that unless you're in one of the lowest tax brackets, you should avoid them like the plague.
Let me start out by stating that I don't hate Roth 401(k) and 403(b) accounts. That being said, the advice I consistently give my physician-clients is that unless you're in one of the lowest tax brackets, you should avoid them like the plague.
Here's why. When you contribute money to a 401(k) plan or 403(b) plan at work through salary deferrals, the money you contribute reduces your taxable wages and grows tax-deferred. Let's say you're in the 35% federal tax bracket and live in a state with a 5% income tax. Assuming you max out your salary deferrals this year, you'll save $5,890 in taxes on your $15,500 of contributions. Invest that tax savings at 8% over 30 years, and this year's tax savings will grow to be worth $60,000.
When you go with the Roth version of these plans, you voluntarily forego a tax break this year in exchange for a PROMISE from the government that you can make tax-free withdrawals from these accounts when you retire. Basically, the government is asking you to pay higher taxes this year, and then you or your heirs can access that money without paying even a dime in taxes, assuming the rules don't change at some point before you retire. Sounds pretty good, huh?
Hogwash I say. Yes, hogwash. I don't trust the gang in Washington one bit to keep this promise. Especially since 25 years down the road, it will be a whole different crew of politicians in Congress who will be tinkering with the tax rules that were put in place by the current crew of politicians. And if you remind them about the promise they made, they will simply remind you that it wasn't they who made the promise.
How can I say such a thing? Simple, because this exact scenario has happened before. Each week when you get paid, your employer withholds social security and Medicare taxes from your pay. Are you aware that you don't deduct the Social Security taxes you pay during the year? Yes, the money you pay into Social Security is post-tax dollars, just like the salary deferrals you contribute into your Roth 401(k) or 403(b).
Now, here's where things get a little scary for you lovers of the Roth 401(k) or 403(b) accounts. When Social Security was first enacted, any benefits received were not supposed to be taxable. Post-tax contributions and tax-free withdrawals. Does that ring a bell?
Well, at some point, the government needed money, so they made social security benefits up to 50% taxable. And then, in 1994, the government again needed money, so they made Social Security benefits up to 85% taxable. How confident can you be that the same exact thing won't happen with your Roth accounts? Actually, I'm fairly confident that they WILL find a way to somehow make Roths taxable in my lifetime. As a matter of fact, my brother and I did not bother to amend our firm's 401(k) plan to add the Roth option.
When I rant about Roth 401(k) and 403(b) accounts to my high income clients, some have called me a hypocrite since I also tell them to make a non-deductible IRA contribution in anticipation of converting that money to a Roth IRA in 2010. But with that strategy, you're not giving up a current year tax deduction to be able to end up with some money in your Roth account.
My final thought is that our elected representatives in Washington are probably pretty proud of themselves for coming up with the Roth 401(k) or Roth 403(b). Every time a highly compensated person opts to go with the Roth version of these salary deferral plan, it's more money in the government coffers this year. And nothing puts a smile on a politician's face quite like that.
Andrew D. Schwartz, CPA is the founder of The MDTAXES Network, a national network of CPAs who specialize in providing tax services to healthcare professionals. A frequently-quoted tax advisor, his firm of has over 45 years of combined experience specializing in the tax issues affecting health care professionals. For more information call 800-471-0045 or e-mail, email@example.com.