In 1997, then-President Bill Clinton signed into law the Taxpayer Relief Act, (TRA) and with that signature was born the Roth IRA. Its namesake, Senator William Roth, was a Republican from (ready?) Delaware and Clinton was a notorious tax raiser. Somehow, the stars aligned, and TRA became the law of the land.
Twenty-three years earlier, Congress first authorized (Traditional) Individual Retirement Accounts (IRAs), and Americans slowly began to realize the benefit of pre-tax saving to enhance future retirement income. Similarly, Roth IRAs got off to a slow start, and over time have become popular because of their unique tax properties. Although the Roth IRA owner does not receive a current tax deduction for contributions, neither does he or she pay tax on later distributions, regardless of the growth in the account over time.
Non-taxation of Roth IRAs, and now Roth 401(k)s, has fueled speculation over several years regarding potential future taxation of withdrawals from Roth accounts. Personally, I have long feared that Congressional avarice may one day lead to taxation of growth in Roth IRA accounts as withdrawals are made. Others fear that all withdrawals may become taxable events, but even this skeptic does not support that theory. Taxing withdrawn contributions would constitute a direct double-tax situation, which is distasteful to politicians.
Most arguments in favor of retaining Roth non-taxation status quo do not comfort me. My fears are based on the inability of Congress to even slow their spending and accumulating unsustainable national debt. Remaining are few options for Congress to close the annual budget deficit, so untaxed Roth appreciation attracts scrutiny.
Indirect taxation of Roth withdrawals has already begun, though in a clandestine manner. The SECURE Act was a response to the COVID-19 pandemic and included several changes to retirement accounts. Notably, SECURE removed the “Stretch IRA” provision for most non-spouse beneficiaries of IRA owners. Replacing the Stretch option (withdrawals allowed over the lifetime of an inheritor) is a 10-year requirement to drain the account completely. While not a direct tax on the inherited funds, tax-free growth is limited to 10 years, after which the money must be distributed to the inheritor. Further investment of withdrawn proceeds is then taxable sooner than in pre-COVID years.
Probabilities of future higher personal tax rates drive most Roth investors to trade current deductions for after-tax contributions by switching from Traditional IRAs and 401(k)s to Roth IRAs and 401(k)s. Everyone’s situation is different, and a thorough review of the possibilities with a professional financial planner will be helpful.
Experience indicates that my fears place me in a small minority of investors and advisors. Nonetheless, evaluate your possibilities before deciding.
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