It has been a tough five years for the “expert” class. The anti-expert narrative got a huge boost with the Covid pandemic – total shutdowns were a disaster, and it was especially hard on school-aged children. The vaccine did not live up to the hype. Most embarrassingly, debate on what would be the best path was silenced and any view that did not align with the approved narrative was labeled as “misinformation.” That was a huge mistake, and the ramifications are being felt today.
We now have a significant group who are convinced that the experts are always wrong. This is human nature, that we always seem to overcorrect from the most recent problem. It brings to mind one of my favorite quotes from Benjamin Graham, “The stock investor is neither right or wrong because others agreed or disagreed with him; he is right [or wrong] because his facts and analysis are right [or wrong].”
One night I was sitting at a bar in Midway airport having a drink with a friend and colleague who works for a large 401(k) provider (I note this to emphasize that he was not a naive person with limited financial understanding). Somehow the subject of Roth retirement plans came up, and he was thinking about converting some or all of his 401(k) into a Roth. His neighbor had just been to a multiple-day presentation put on by a self-described “expert” who had a detailed presentation on why conversion to Roth was the right path. (I’ll get back to our “expert” in a moment.)
I blurted out, “Are you crazy?” (In my defense this was a colleague…I am much nicer to clients than I am to colleagues.) He was startled because he had not heard anyone push back so forcefully on the folly that is the Roth. Roths are popular and the world is full of “experts” who will tell you how wonderful they are, but they are not right or wrong because they are popular; they are right or wrong because their analysis is right or wrong. In this case, it is wrong.
Quick reminder: traditional retirement plans give the investor a tax deduction on her contribution, the money grows tax-deferred, and then she will pay taxes when she takes the money out in retirement. With a Roth, she pays taxes today and is promised tax-free income in retirement.
What is their analysis? A quick Google AI search will give you the highlights. The number-one argument for Roth is that the investor expects higher tax rates in retirement. If one believes that they will pay a higher rate in retirement, then he would be better off paying the lower rate today, or so the argument goes. The problem with this argument is that it defies reality. According to the Center for Retirement Research, four out of five retirees pay little to no income tax. So, for the vast majority of the population, if one chooses to contribute to a Roth instead of the traditional plan, then he is giving up a tax deduction now to save on a small to nonexistent potential future tax bill. If he converts, then he is giving himself a large tax increase today to avoid a small or nonexistent bill in the future.
Back to my colleague’s neighbor’s multi-day seminar on the virtue of Roth. The “expert” started his Roth presentation as most Roth devotees do, with the sad analysis of our country’s fiscal situation. The runaway government debt, he argued, meant that taxes are all going up in the future. Ultimately everyone who believes in Roth gets to this point: “Taxes are going to be higher in the future.” Really? Who are these politicians who are going to raise taxes across the board, especially on retirees?
Most politicians want to avoid raising taxes on anyone, but those who are not afraid of the T word always want to tax only one group of people. You know who I’m talking about – “the rich.” Who are these rich? In the Secure Act 2.0 of 2022, they would be any employee making $150,000 or more (it was originally $145,000, but they adjusted for inflation). Anyone in that group who makes a “catch-up” contribution to their retirement plan must put that contribution into a Roth. This was explicitly used to pay for other benefits in the act. In other words, that is how politicians raise taxes – force retirement savers into Roth.
This gets to the other unspoken issue with Roth: The investor is trading a known tax deduction for a promise. If the tax situation is as bad as my colleague’s neighbor’s expert claims, then what is more likely: an across-the-board tax increase on all, or the removal of the tax-free status on those rich folks who have Roths? In the 1980s when Social Security had to be saved, they did so primarily by taxing the benefit which had been previously promised to be tax-free. Keep I mind that the overwhelming majority of retirees are in a lower tax bracket in retirement, so the increase would have to be large enough for that lower bracket’s rate to be higher than the higher bracket’s rate while working. Never say never, but the odds of that occurring are incredibly remote.
Finally, the question everyone asks is whether a Roth is better than a traditional retirement plan, but a more interesting question is whether a Roth is better than a regular brokerage account. This is a hard question to answer because it will depend heavily on how the account is invested. If it were invested in our core equity strategy over the last five years, the experience would be as follows: In 2020 the gain was 23.39%, but only 3.6% was realized; 2021 gained 15.09% with a realized gain of 9.7%; In 2022, we had a loss and took a tax deduction; 2023 saw a gain of 12.8% and a realized gain of 1.8%; 2024, a gain of 31.52% and a realized gain of 4.4%. Realized gains were all taxed at long-term capital gains rates, not income tax rates.
This is just an example for educational purposes. The point of this real-world example is that in a prudently managed brokerage account, the taxable consequences are not great and therefore the benefit of the Roth is not great. It is more than nothing, but does it outweigh the strings that are attached, like five-year lockup and other retirement plan rules?
That answer is not as clear as Roth vs. a traditional retirement plan, but there are many who might argue the added flexibility of the brokerage account outweighs what small tax benefits one would get in a Roth. With the Secure Act 2.0 Roth provision taking effect in 2026, many plans that did not previously offer Roth will be forced to do so. Does that mean you should switch? Being popular doesn’t make it right. The facts and analysis say you shouldn’t, regardless of what “experts” might say. At least that is my perspective.
Warm regards,
Chuck Osborne, CFA
