16 Roth Mistakes Many People Make (and How to Avoid Them)

About this video

• Video Title: 16 Roth Mistakes Many People Make (and How to Avoid Them)
• Channel: The Retirement Nerds
• Speakers: Eric, Zach
• Duration: 01:01:21

Overview

This video identifies and explains 16 common mistakes people make when dealing with Roth accounts (IRA and 401k). The hosts emphasize a "data over dogma" approach, encouraging viewers to analyze their specific financial situations rather than adhering to rigid rules. They cover a range of errors, from mathematical misunderstandings to overlooking long-term implications, aiming to help viewers make more informed decisions about Roth contributions and conversions.

Key takeaways

• Misunderstanding Commutative Property: People mistakenly believe the order of operations (balance, tax rate, years, growth rate) affects the final outcome of investments, which is false if the variables remain the same.
• Confusing Tax Rates: A common error is confusing marginal tax rates with effective rates, leading to incorrect calculations for Roth conversions and contributions. The actual tax cost is based on the marginal rate, but considering the "marginal cost of conversion" provides a more accurate picture of the expense.
• "Magic Taxes" Fallacy: This refers to the false equivalence of comparing a $10,000 Roth contribution with a tax cost to a $10,000 traditional contribution without accounting for the tax savings from the traditional option.
• Improper Handling of Conversion Taxes: A mistake is believing that one cannot do a Roth conversion if they don't have separate cash to pay the taxes. While having separate cash is optimal, not having it doesn't necessarily prohibit conversions, especially for those over 59.5.
• Short-Term Focus: Roth conversion strategies should not be viewed as a one-year decision. Comparisons should span multiple years or the entire retirement horizon to determine the most advantageous approach.
• Using Different Growth Rates: While investing Roth assets more aggressively is logical, using this as the sole justification for conversion without considering other factors like tax bracket can be a mistake.
• IRA as an Investment: Mistaking the Roth or Traditional IRA/401k as an investment itself, rather than an account type that holds investments, is a misunderstanding of their function.
• Forgetting Tax Diversification: Not recognizing that matching contributions in a 401k (even if Roth contributions are made) can create automatic tax diversification between pre-tax and Roth assets.
• Incorrectly Applying Income Limits: Confusing income limits for IRA contributions/deductions with those for 401k contributions, which do not have the same income restrictions.
• Ignoring New Realities After Conversions: Failing to recognize that Roth conversions create a new financial reality and alter future tax planning options, potentially leading to missed optimization opportunities.
• Misunderstanding Five-Year Rules: Confusing or misapplying the various five-year rules associated with Roth IRAs, particularly concerning conversions and earnings withdrawals.
• Approaching Roth/Traditional Dogmatically: Being overly rigid ("religious") about choosing only Roth or only Traditional accounts without considering the benefits of having both for tax flexibility.
• Improper Software Modeling: Relying on financial software that doesn't accurately model the nuances of tax bracket management and withdrawal sequencing in retirement can lead to suboptimal planning.