When Should You Not Open a Roth IRA?

Setting yourself up for financial security in retirement means considering a number of options for saving and investing. A Roth IRA (individual retirement account) is one popular retirement savings tool because it can provide a source of tax-free income in retirement. Roth IRAs don't offer tax savings at the time you make contributions, but qualified withdrawals in retirement are tax free.

These accounts aren't ideal for everyone, however. Alternatives like 401(k)s or traditional IRAs may be a better choice in some cases. Consider factors from your tax bracket to your anticipated retirement age when you’re determining whether you should open a Roth IRA. 

The Perks of a Roth IRA

A Roth IRA is funded with after-tax dollars that then grow tax free within the account. These accounts do have some limitations and requirements and they don’t provide immediate tax advantages, but they can be much kinder to your tax situation in the long run.

Contributions to a Roth IRA are made with after-tax income so you can then make withdrawals in your retirement years tax free, including any earnings.

Roth IRAs don't require mandatory withdrawals in retirement the way traditional IRAs do, and you can withdraw your contributions (although not necessarily your earnings) at any time without penalty. You can withdraw your earnings before your retirement age under certain circumstances, such as if you become disabled or if you're using the funds to buy your first home.

You can contribute up to $6,000 of your taxable income in 2022, or $7,000 if you're over age 50. These limits increase to $6,500 and $7,500 in 2023.  

Many individuals use a Roth IRA due to their flexibility with withdrawals. You can take your contributions out at any time, and withdrawals in retirement aren’t mandatory based on age. You can contribute up to the maximum amount in every year that you earn income and otherwise qualify until death. Then you can pass the account on to a beneficiary.

When a Roth IRA Doesn’t Make Sense

A Roth IRA has many advantages, but other retirement savings accounts with different features may make more sense in some situations. Here are a few situations in which opening a Roth IRA may not be the best financial strategy. 

If You’ll Be in a Lower Tax Bracket in Retirement

Consider what your taxable income is likely to be when you retire. A Roth IRA might not be a good option if you expect to be in a lower tax bracket later because you won’t have the same taxable income from employment. You might be better off taking a deduction now for your contributions to a traditional IRA or another pre-tax account, then paying taxes on your withdrawals in a lower tax bracket upon retirement. 

Making contributions to pre-tax accounts like a traditional IRA can potentially affect your tax bracket for that year, David Haas, CFP with Cereus Financial Advisors, told The Balance. “[Selecting a retirement account] depends on whether your income is close to a tax bracket edge where a pre-tax contribution might lower your tax bracket,” Haas said.  

If Your Earnings Exceed the Limits for Roth IRAs

Roth IRAs have income limits. You can’t contribute if you earn above a certain threshold. The Internal Revenue Service (IRS) uses the following modified adjusted gross incomes (MAGI) as the limits for contributing to a Roth for 2022:

• $214,000 if you’re married and filing jointly
• $144,000 if you're single, head of household, or married and filing separately but you didn't live with your spouse at any time during the year
• $10,000 if you're married and filing a separate return and you lived with your spouse at any point during the tax year 

These limits are adjusted for inflation so two of them increase in 2023:

• $228,000 if you're married and filing jointly
• $153,000 if you're single, head of household, or married and filing separately but you didn't live with your spouse at any time during the year

You are not eligible to contribute to a Roth IRA at all if you earn above these income thresholds. The amount that you can contribute begins reducing at lower limits:

• $204,000 in 2022 or $218,000 in 2023 if you're married and filing jointly
• $129,000 in 2022 or $138,000 in 2023 if you're single, head of household, or married and filing separately but you didn't live with your spouse at any time during the year

Other retirement plans such as a 401(k) or a traditional IRA typically do not have income caps. 

If You Haven’t Maxed Out Your Employer Match

Employers often offer retirement plans with matching 401(k) or 403(b) funds. It may be a better choice than a Roth IRA if you have this opportunity.

“Most employers match their employee's contributions, at least up to 5% of their salaries,” Haas said. “If you don't get that match, you're leaving money on the table.” Matching funds are essentially free retirement money you could be getting if you choose that retirement account over a Roth IRA. Your employer will contribute a little money each time you make a contribution.

If Your Time Horizon Is Short

A Roth IRA may not be the best financial decision if you have a shorter timeline for making contributions because you're nearing retirement age. A shorter time frame makes accounts with instant tax benefits more suitable.

You must meet the IRS standards for a qualified distribution to ensure tax-free withdrawals, including that you are at least 59½ years old and the Roth has been open for five years or longer. There are exceptions to the withdrawal tax, however, such as when:

• You become disabled
• Payment is sent to a beneficiary 
• Payment covers a first home purchase

Other Ways To Invest

Consider alternative options if your unique situation isn't ideal to open a Roth IRA. This might include:

• Traditional IRA: A traditional IRA is an individual retirement account with deductible contributions and tax-deferred growth. These are often created in addition to or in replacement of an employer-sponsored account. 
• 401(k): A 401(k) is an employer-sponsored retirement account that allows employees to contribute a set amount of their wages to the account. Some employers may match up to a certain percentage of your own contributions.
• 403(b): Tax-exempt organizations can offer employees 403(b) plans that function very similarly to a 401(k), including the option for employer-matching funds. 
• 457(b): This is an employer-sponsored retirement account for certain government employees that allows them to contribute pre-tax dollars toward retirement. Most notably, a 457(b) does not have a 10% early withdrawal penalty.

The Bottom Line

A Roth IRA is a valuable savings tool for many people investing toward retirement with its tax-free growth and flexible withdrawals. But it may not be ideal for others depending on factors such as tax status, income, and retirement timelines.  

Review your current financial situation, retirement plans, and employer’s offering before deciding if you’re considering opening a Roth IRA. Consider consulting a professional financial advisor who can guide you through retirement savings options that can best fit your specific needs. 

Frequently Asked Questions (FAQs)

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