IT DEPENDS!

Okay, I really wanted to just leave this as a two-word blog post, but I decided that probably wasn’t all that helpful. The genesis of this post was a discussion on Facebook where people were giving advice about what account someone should invest money in. Often these folks are really big fans of Roth accounts (as am I) and the advice is often similar to this, “If you are in the 12% or lower [federal] marginal tax bracket, then contribute to Roth. If you are in the 24% or higher than contribute to Traditional. If you are in the 22% bracket it could go either way, but most likely Roth because of [reasons].” This advice is fine as far as it goes, but my concern is that it doesn’t go nearly far enough.

The advice above may indeed be really good advice, but the vast majority of the time in these discussions on Facebook (and elsewhere) we do not have nearly enough information about the person to determine if that’s good advice or not. I am not a financial advisor nor am I a CPA, so I’m sure there are many, many, many other considerations I haven’t thought of, but even with my lack of knowledge here are a few things that I thought of in less than 5 minutes. (These are in no particular order, just the order I thought of them in.)

• HSA: Does the person have an HSA-qualified High Deductible Health Insurance plan? If so, are they maxing out their HSA contributions and investing them? An HSA is almost always going to be better than either a Roth or Traditional account. (Except if you live or plan on retiring in California or New Jersey, in which case there are complications.)
• Student Loans: Do they have student loans? If so, are they on an income-based repayment plan where pre-tax deductions will not only save them on their taxes, but it will lower their student loan payments? And how many more payments do they have until possible loan forgiveness?
• State Taxes (Current and Future): The standard advice above ignores state taxes. While state taxes are typically lower than federal, they shouldn’t be ignored and there are multiple aspects that have to be looked at.
  • What is their current marginal tax rate for their state income taxes (if any)? (Unless you live in Pennsylvania because they don’t allow you to deduct pre-tax contributions.)
  • What state do they plan to live in when they retire and how does it tax retirement income? (Some states don’t tax it at all, some tax all of it, some let you exclude certain types in certain amounts. There are lots of arbitrage opportunities here that can make the case for either Traditional or Roth depending on your specific situation.)
  • Are there other state income tax credits they might qualify for that are phased out (or cliffed) based on income?
• Federal Tax Credits and Surcharges: Are there federal tax credits they might qualify for that are phased out (or cliffed) based on income? Things like the American Opportunity Tax Credit, Savers Credit, ACA subsidies, IRMAA surcharges, etc.
• Marital Status: Are they single, married, or divorced? And do they anticipate being the same status in retirement? If divorced, do they have a DRO that has provisions regarding their (or their ex’s) retirement accounts? Will they qualify for Social Security spousal or survivor benefits?
• Children and Post-Secondary Education: Do they have kids, how old are those kids, and do they want to help them with post-secondary education? If so, then they need to think about both 529s and FAFSA.
• Inheritance: Do they anticipate a decent inheritance? If so, when, how much, and in what types of accounts? (For example, if they will inherit sizeable traditional accounts, they will have to take RMDs over the first nine years and then possibly a large lump sum in the 10th year).
• Legacy: Do they plan to leave a legacy for their heirs and, if so, is part of their investment strategy taking into account their heirs’ taxes? (And might a better choice be to gift the money to them now instead of investing it in your own name.)
• Charitable Contributions: Do they contribute to charity now and/or want to leave a fair amount to charity as part of their legacy? Then they should consider Donor-Advised Funds and QCDs. (When you leave money in a traditional, pre-tax account to charity, they don’t owe any taxes, so that money ends up never being taxed.)
• Age and Retirement Age: What is their current age and what age do they plan on retiring? And when they retire what will be their income sources? Will they receive a pension and, if so, at what age? What about Social Security? Will they need (want) to withdraw from retirement accounts early in retirement? For example, for someone who wants to retire very early (before they can collect pension, Social Security, or even withdraw from tax-advantaged accounts), investing in a taxable brokerage account might make more sense as they might be able to sell at a 0% capital gains tax rate. Or maybe they plan on doing Roth conversions between the time they retire and their RMD age (73 now, 75 soon).
• Spending in Retirement: What are their anticipated spending needs in retirement? Is it about the same as now, a lot more, or a lot less?
• Investment Choices and Fees: What are their current investment choices and fees in the various accounts available to them? What about other investment areas? Maybe they need a new HVAC system and “investing” in a heat pump system with tax credit support will pay them more in the long run than investing in the market.
• Debt: Do they have high interest debt (say 5% or higher)? Then there’s a decent chance it would be better to put any extra toward that instead of investing.
• Current Investments: What is the balance of their current investments and what is their tax allocation?

Again, these are just the things I thought of in less than 5 minutes. I’m sure the list is much, much longer. This is where I need to include the obligatory, “Personal finance is personal;” we really need to know a lot more about a person’s situation before we quickly dash off, “Roth IRA!”. I’m sure I sometimes also say things online that don’t take everything into account, but I try to at least provide some caveats when I do that it may not be taking everything into consideration. That doesn’t mean that people giving advice on Facebook (and other places) are doing something “bad,” but it does mean that we need to be careful to assess a person’s entire financial situation instead of assuming that “you should contribute to your Roth IRA first” is the best advice to be giving.