Roth taxed in the future?

[sweeps]

This issue crosses my mind occasionally and I saw a topic posted on another site...

We're all stuffing our Roths right now with dreams that all the earnings will come out free from taxes 20, 30, 40 years from now. But what if that changes and Congress decides to tax Roth earnings in the future? Are we overcommitting on the Roth?

If Congress doesn't tax Roth earnings directly, they could still tax it indirectly. One suggestion I saw was that even though the earnings themselves wouldn't be taxed the income would be added to your gross income and could still push you into a higher tax bracket.

[Fern]

They're so popular i think there would be a huge uproar if they tried to do that.

[disneysteve]

I don't think they would ever tax the contributions, since those have already been taxed and there is a double taxation issue there. They could decide to tax the earnings, in which case you'd be no worse off than if you had invested in a traditional IRA or a 401K since those distributions are already taxable.

Realistically, though, I don't see that happening.

[pearlieq]

I think it's possible, but not very likely. Still, it's something to keep in the back of your head.

Keep it in mind when you're investing--don't put all of your eggs in one basket. Put some in a 401k, some into fixed assets, some into a Roth, etc. That way if any one of those means is changed, you're still shielded from some of the fallout.

[sweeps]

Another possibility is Congress could tweak some of the other features of a Roth. For example, imposing a required minimum distribution or charging a fee for withdrawing contributions before retirement.

No agenda here, just questioning whether it's possible to be irrationally exuberant about the Roth over other investment vehicles.

[disneysteve]

Originally Posted by sweeps

Another possibility is Congress could tweak some of the other features of a Roth. For example, imposing a required minimum distribution or charging a fee for withdrawing contributions before retirement.

Sure. Just like SS has changed and will change more in the future. All of these government-sponsored plans are subject to the whims of Congress. We can only invest based on the knowledge we have since none of us has a crystal ball.

[mbrasher1]

This is a concern. As one who worked on Capitol Hill for 10 years (and has a Roth IRA), it is always a danger, esp when future Congresses will be pinched to pay for: Medicare for the elderly; bailing out Social Security, etc. When taxes are being increased across the board to pay for these past and future govt commitments, some will look at the Roth IRAs.

However, Congress will be constrained by the number of investors who have Roths. There will certainly be some tweaks and perhaps future limits to Roths. But it is difficult to imagine how Congress could eliminate the tax-free withdrawal feature of Roths: it is the reason for its existence.

I think that retirement investors would have more to worry about taxes shifting to consumption from income. This, too, would significantly increase effective tax rates for Roth investors. Both risks are there, but it should not deter you from making Roth investments. We plan with the rules we have...

[Broken Arrow]

My crystal ball is a bit foggy, but I have to agree with Steve and others. There is a double taxation issue here, and I just honestly do not see that happening.

However, I also agree that they can always tweak other features such as the annual contribution limit. I realize that they're suppose to increase to keep pace with inflation, but they could always decide to not increase it. In fact, nothing says that they can't decrease it.

Although to be perfectly frank, I think the limit is already too small as it is. If the government wants alleviate the healthcare issue and encourage its citizens to save, we would all benefit more in the long run if they greatly increase the limit now.

[tinapbeana]

Originally Posted by Broken Arrow

Although to be perfectly frank, I think the limit is already too small as it is. If the government wants alleviate the healthcare issue and encourage its citizens to save, we would all benefit more in the long run if they greatly increase the limit now.

i would agree on the low-limit opinion. 4k contribution limit, and the median income is what, 43k? or so? that's less than 10%....

if the cap on 401ks is 15k per year, wouldn't a simple yet effective Roth limit be the equivalent of the 15k after taxes?

[scfr]

The estate tax ends up being double taxation for some ... so there's no reason it couldn't happen with Roth IRAs, except that it would impact more voters than the estate tax and therefore be less popular politically.

I'm not as big a fan of the Roth IRA as some others on the board; I prefer to get my tax savings NOW.

[disneysteve]

Originally Posted by Broken Arrow

Although to be perfectly frank, I think the limit is already too small as it is.

This was one big screw-up of the government. They started IRAs with a $1,500 limit in 1974, raised it to $1,750 in 1976 and again to $2,000 in 1981 and then totally ignored it for 21 years, not increasing the limit again until 2002 ($3,000) and 2004 ($4,000). Had it been indexed to inflation from day one, we could have been stashing tons more money in our accounts all this time.

For those of us who have no employer-sponsored plan and are limited to what we can put in our IRA/Roth, this has been a major problem.

[tinapbeana]

Originally Posted by disneysteve

For those of us who have no employer-sponsored plan and are limited to what we can put in our IRA/Roth, this has been a major problem.

*raises hand, stomps feet, and contemplates holding breath till the limit is raised...*

i feel your pain, steve...

[MonkeyMama]

Well, let's put it this way. I think your concerns are very valid Sweeps, and with the way the government is running up a huge deficit I have no doubt in the 30-40 years when I Retire that ROTHs as they exist today will be unlikely. BUT government does not generally to retroactive tax changes. So I do feel safe assuming everything I put in, and earn, until they change the law will be tax free at withdrawal. I don't even want to think about the nightmare that would impose on tracking what portion is taxable and not, but the nightmare already exists somewhat with all the different IRAs, nondeductible contributions, conversions, differences in state laws, etc..

You know the government recommends you keep every form 1040 and retirement-contribution related records and forms FOREVER and this is precisely the reason why.

Not putting all your eggs in one basket is probably the safest bet. But if ROTH puts you way ahead I don't think it is the worst to rely on it for the time being. When/if the law changes you can change your strategy.

[Scanner]

For those of us who have no employer-sponsored plan and are limited to what we can put in our IRA/Roth, this has been a major problem.

DisneySteve,

I am not normally a fan of Kisoysaki of Rich Dad/Poor Dad but this is a good reason for everyone to own at least a part-time business - you have a generous availability of self-employed tax sheltered accounts.

I think a SEP-IRA for instance allows you 25% of your profit to a maximum of 42,000 year you can stuff away. So, even if a part-time business only nets $10,000 year (selling widgets on ebay or a Christmas tree farm), you can stuff an additional $2500 away in addition to the Roth you own.

Not only that, if the business is out of your home, you can partially deduct your house as per your acccountant's advice on that - that can be huge. I probably deduct 10%-15% of my house for business related purposes.

[MonkeyMama]

Yes - good point.

Steve, what you need to do is arm yourself with info on safe harbor profit sharing/401k plans and make a proposal to your office. Our clientele is primarily small medical practices and they ALL have a 401k/PS plan. The benefits are huge in that industry - it works out very well. With a safe harbor plan you only have to pay office staff 3% PS & yet you can set up a 401k to go with it and the doctors can take the max contributions (28k/year PS if they make 220k+ & also the 15k 401k). It skirts a lot of the top heavy issues with standard PS & 401k plans. My boss has talked the biggest cheapos into this plan - it saves them bundles in taxes as the owners can put away 44k for themselves every year tax-free. Plus the tax deduction for employee contributions. I am not sure about NJ, but in Cali state taxes are very high and these plans are gold to small medical offices.

[disneysteve]

Originally Posted by MonkeyMama

Steve, what you need to do is arm yourself with info on safe harbor profit sharing/401k plans and make a proposal to your office

The topic has come up, but I think the problem is I'm the only fiscally sound employee in the practice. The 3 full-time employees all live paycheck to paycheck and probably would not sign up for a 401K. The other doctor spends money like water - leases a luxury car every 2 years, shops online constantly, goes to concerts, bought a shore house recently, etc. He is 4 years older than me and is still repaying student loans, while I repaid mine over 3 years ago (similar original debt amounts). I've built a mid 6-figure portfolio. He's saved next to nothing. So the appeal of setting up a 401K seems to be lost on my coworkers.

Steve, there's a confirming lesson to be learned there for everyone that income has nothing to do with your ability (or willingness) to save.

You can be just as oblivious at any income level.

Thanks for sharing those details.

[poundwise]

Originally Posted by sweeps

We're all stuffing our Roths right now with dreams that all the earnings will come out free from taxes 20, 30, 40 years from now. But what if that changes and Congress decides to tax Roth earnings in the future?

Just to note...

This doesn't sound like a "Hopeless Optimist" at all!

[sweeps]

Originally Posted by poundwise

Just to note...

This doesn't sound like a "Hopeless Optimist" at all!

On the contrary... I made the optimistic assumption we'll all be around 20-40 years from now.

[cptacek]

I don't think they would ever tax the contributions, since those have already been taxed and there is a double taxation issue there. They could decide to tax the earnings, in which case you'd be no worse off than if you had invested in a traditional IRA or a 401K since those distributions are already taxable.

This isn't quite true. You were taxed on the money you put in, so let's assume that Congress won't tax that. But, if you are taxed on the earnings, then your Roth IRA just became a plain-old, typical mutual fund. So, if the laws change, it is worse than if you had invested in a traditional IRA or 401k, because at least with those you got the tax savings up front.

I think the first thing that will go if they start taxing a Roth is the "no taxes to the beneficiaries" clause. Then the "no minimum distribution" clause would change. The last thing they will change will be taxing the earnings for the person who put the money in, IMHO of course.

I myself will continue to contribute the max to my Roth IRA. If the law changes, so be it. But I'm not going to bet on it.