The Roth Regret Phenomenon

There’s a common regret among retirees. It’s that they wished they had saved more of their money in Roth accounts. This appears to be the case, even when saving money in pre-tax accounts was mathematically the right decision to make. Why? I have a hunch.

The Regret

I recently asked a group of retirees on Facebook if they had any regrets when they entered retirement. I got about 70 responses and overwhelmingly the most common regret was not having enough in after-tax i.e. Roth dollars heading into retirement. The regret is easy enough to understand. Every dollar pulled from a tax-deferred account is taxable income. When you’re working, lowering your taxes often involves putting money in those same tax-deferred accounts. But when you retire, the savings spigot shuts off and the spending spigot turns on.

All of a sudden you’re confronted with anxieties about how much you’re spending, how long your portfolio will last and so on. And then when you do spend, you’re constantly setting aside 10%-24% or more for state and federal income taxes. You’re nervously eyeing IRMAA thresholds. If you’re under the age of 65 you might be concerned about your ACA subsidies. That feels like a very real punch in the gut.

If only you had more Roth dollars, all of those concerns could have been alleviated. You might recognize rationally that the strategy you pursued during your working career was the mathematically optimal strategy. After all it doesn’t take a lot of math to show that deferring tax at a higher rate than you withdraw it is a win for you. But that doesn’t seem to change the FEELING of regret.

And it might not just by a psychological or perceptual phenomenon. Sometimes (most times?) your goals at 65 are different than your goals at 35. In your 30’s, 40’s, and 50’s you are trying to reduce the taxes from your high earning years. You’re trying to build the biggest retirement portfolio you can. But at 65, many people begin to turn their attention to their legacy to their heirs. They start learning about the 10 year rule and wondering how they might alleviate the tax hit to their heirs.

Once again, they come to the conclusion that Roth dollars would have been much more beneficial. Sure, they can make Roth conversions. But who wants to write a $50,000 or $60,000 check to convert a few hundred thousand dollars?

The Reason

The math doesn’t matter when it comes to the Roth Regret Phenomenon. Because the Roth Regret Phenomenon is not about math. It’s about the abrupt psychological shift that takes place when you enter retirement. The tax bills you owe today are much more salient than the tax savings you benefited from 20 years ago. It doesn’t matter if the tax savings from 20 years of pre-tax contributions outweigh the tax bill today.

The Roth Regret Phenomenon is also about shifting goals. What you care about at 65 is very hard to foresee at 35. And even if you could foresee it, it might not have the emotional weight to prompt you to actually do anything about it.

The Solution

The solution here is simple. We can recognize that humans are not optimization machines (and if we are we certainly are not optimizing for money). We can also recognize that it’s impossible for us to know who we will be decades hence; i.e. what will be important to us, what our goals will be, etc.

Anytime there is uncertainty, we hedge to one degree or another. What does hedging here look like? It looks like setting aside some money in a Roth account and/or taxable brokerage account, even if it’s only a little bit and even if it’s not the mathematical optimum given the information you have today. If it makes you feel better, you could tell yourself a story about how what you’re doing is rational given the uncertainty of the future tax code (that’s what I tell myself).

But really, it’s not all about the mathematical optimum but the human optimum. Recognize your humanity. Don’t try to be a computer.