Disadvantages of Roth IRAs

A Roth IRA is an alternative type of individual retirement account (IRA) that allows individuals to make after-tax contributions and leave their money in the account to grow during their lifetime. This type of IRA is attractive to people who don’t need the tax deduction, because they aren’t required to take distributions later in life. But Roth IRAs also may have disadvantages as a retirement investment option. 

Find out more about some of the disadvantages of Roth IRAs, including contribution limits, tax issues, and penalties.

Roth IRA Contributions Aren’t Tax-Deductible

A traditional IRA allows individuals to make before-tax contributions for retirement, and these funds aren’t taxable until the year they are withdrawn. In the same way, a 401(k) plan or other type of employee retirement plan allows employees to contribute to a retirement account through their employers and then take a tax deduction.

But if you contribute to a Roth IRA, it must be with after-tax dollars, so your contributions aren’t tax-deductible. You must pay the taxes on the income before you make the contribution, and you can’t defer the taxes to a later year.

Roth Contributions Are Limited 

The amount you can invest in a Roth IRA each year is limited, based on your filing status and your modified adjusted gross income (MAGI). The maximum amount changes every year.

For example, in 2023 your income must be below $153,000 (for single filers) if you want to contribute to a Roth IRA. In 2022, the limit was $144,000. The limits are different for married filers:

The limit on Roth IRA contributions is the lesser of:

• $6,000 in 2022 and $6,500 in 2023 (or $7,000 in 2022 and $7,500 in 2023 if you're aged 50 or older)
• Your taxable compensation for the year

These limits are the same as traditional IRAs but lower than some other types of IRAs. For instance, the 2023 limit on a SEP IRA for business owners and employees is the lesser of $66,000 or 25% of compensation for each participant. It was $61,000 in 2022.

Employers Can’t Set Up Roth IRAs For Employees

Employers have several options for setting up and contributing to retirement savings plans for employees, but these don’t include Roth IRAs. Employers can’t set up Roth IRAs and make direct contributions to them for employees, but any employee can use income from work to make their own Roth contributions. 

An employer can set up a Payroll Deduction IRA with a financial institution. Individual employees can then designate amounts from their pay (after tax) to make contributions to their own Roth IRAs. The employer can’t contribute to individual employee Roth IRAs through this plan, however.

Penalties for Unqualified Withdrawals

Standard brokerage accounts don’t have penalties on withdrawals. If you put money into an investment account with a broker you can take it out any time and pay the tax in that year. There’s no limit on how much you can take out or when you can take it.  

But if you take money from a Roth IRA and it doesn’t meet IRS requirements, you may have to pay a penalty. 

You may be penalized with an additional 10% tax on the amount of the distribution. Penalties may apply if you take a distribution within five years from the first tax year of your account or if you take the distribution before age 59 1/2. You or your beneficiaries aren’t penalized if the distribution is held for at least five years and is:

• Due to disability
• Upon or after death
• Used for qualified higher-education expenses, among other exceptions

You can take a one-time distribution to help buy your first home. The exception allows you to take up to $10,000 out of a Roth IRA to pay for specific types of costs without a penalty.

Roth IRAs Can’t Be Changed to Other IRA Types 

You may be able to transfer amounts from traditional IRAs and certain other types of retirement accounts into other IRAs, including Roth IRAs. These are called rollovers, as compared with distributions, because you don’t have access to the funds; they go directly from one IRA trustee to another.  

You may be able to roll over amounts from a qualified retirement plan into a Roth IRA, and you must pay taxes on any untaxed amounts at this time. But you can’t do a rollover of a Roth IRA to a traditional IRA.

Frequently Asked Questions (FAQs)