What's not to love about the Roth IRA? If you open and fund one of these accounts, you get the benefit of tax-free gains on your retirement investments and tax-free withdrawals as a retiree. And at a time in life when money may be tight, getting to keep your withdrawals in full without having to pay the IRS a portion is huge.
Plus, Roth IRAs don't force savers to take required minimum distributions (RMDs). This gives you the option to let your money continue growing tax-free during your senior years. It also makes it easier to pass some of that money on as an inheritance.
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But while Roth IRAs certainly have their share of benefits, there's one major drawback that isn't talked about enough. And it's enough of a negative that it's actually the main reason I'm hesitant to open a Roth IRA.
When it's all too easy to get your money out ahead of retirement
I'm the sort of person who hates wasting money or throwing it away. I make a point to pay my credit cards on time every month, for example, because I don't want to incur late fees. That's just annoying.
Similarly, the idea of a financial penalty does not sit well with me. So in the context of my traditional 401(k), I'm motivated to leave that money alone until at least age 59 1/2 not just because I want to make sure it's there for me in retirement, but because I don't want to hand 10% over to the IRS in the form of an early withdrawal penalty.
But with a Roth IRA, it's really easy to take an early withdrawal without a penalty. As long as you touch only the principal portion of your account, and not the gains portion, you can take a Roth IRA distribution at any time and avoid a penalty.
A lot of people will tell you that's a good thing. But I think it isn't.
Without the threat of a penalty, I could totally see myself tapping my Roth IRA ahead of retirement. And that defeats the purpose of having one in the first place.
Now you could say, "Well, couldn't you just exercise self-control?" And yes, I could certainly try.
But let's put it this way. On an almost daily basis, I tell myself "You will not stuff your face with junk food today." And guess what? Most days I eat junk food.
In other words, I don't always win at the self-control game. And for something as important as retirement savings, I want to make sure I'm doing everything in my power to avoid a financial shortfall once I have to stop working.
Be very careful with a Roth IRA
I want to be clear that Roth IRAs have a lot of perks to offer savers. But if you suspect that you might take advantage of the flexibility to withdraw your principal contributions at any time without penalty, then I'd suggest housing at least some of your long-term savings in a traditional retirement plan instead. You're less likely to tap your nest egg early if it means losing a chunk of the money you've worked hard to save.
