Will Roth IRA Withdrawals Be Tax-Free Forever?

I read this letter to the editor in today’s Wall Street Journal:

“In ‘George W. Bush’s 2010 Tax Miracle” (op-ed April 15), Donald L. Luskin suggests that many wealthy owners of IRAs and other tax-deferred retirement accounts will convert their accounts to Roth IRAs ‘in exchange for freedom from taxes forever after on principal, income and gains.’

“Should anyone be so naive to think that this administration won’t later change the rules and begin to tax all gains on Roth IRAs for those families making above $250,000 per year?”

That’s been one of my concerns too. Not so much that Obama would change the rules but that the rules would be changed at some point in the future. Things the government could do to jack things up:

• Force people to include Roth IRA withdrawals in their income in calculating the tax on Social Security benefits.

• Force people to take RMDs from their Roth IRAs.

• Tax withdrawals for people over certain income thresholds.

I know, I know. I sound like a conspiracy theorist. But, don’t think for a minute that the government won’t change the rules. They’ve done it in the past and they’ll do it again in the future. Anytime they see someone supposedly using the system to their advantage, they’ll figure out a way to close the “loophole.”


20 thoughts on “Will Roth IRA Withdrawals Be Tax-Free Forever?”

  1. I wish I could disagree with you, but there will be too much pressure as the slow-motion train wreck of entitlements (social security, medicare and the new health bill) increase the demand for government funds. Those with higher income or assets will end up paying taxes twice, similar to how dividends are taxed twice. Once when we earn the cash and again when we take it out to spend it.

  2. I’m asking out of ignorance, but could you list an example of when the government changed the tax-status of something after the fact?

    I can envision the government eliminating IRAs, etc, _going_forward_, but I doubt they could change the rules for monies already in the account.

    Perhaps I’m naive…

  3. The government changes the rules all the time. Think about social security. They raised the full retirement age, made benefits taxable and raised the amount subject to taxes. Why did they do this? Because they mismanaged the trust fund.

  4. #3 JLP) I don’t think the SS changes compare that well, but I do see your point.

    A way that the government could change the rules, without breaking the ‘contract’ on Roth Accounts, would be to eliminate the income tax completely, and replace it with a national sales tax.

    That ‘change’, would allow the government to tax the Roth money in a different way — just not through an ‘income’ tax that Roth is immune to.

    I think the best plan is to strive to pay the least amount of taxes possible every year – let the future worry about itself, because as you pointed out, the government can/will do all sorts of sneaky ‘changes’ to ensure they keep their tax revenue streams going.

    Take advantage of whatever tax-shelters/credits that are legally allowed today (401k, traditional IRAs, clunkers, first-time-homebuyers-credit, etc), and also take advantage of whatever tax shelters that may/may not exist in the future. Resist any tax-shelters that promises a future tax savings (Roths come to mind), because the future is not set in stone and there are ways to tax a supposedly un-taxable account (legally).

  5. I’ve been concerned with this since I started contributing to my Roth 401k plan. I plan to retire with substantial assets that will likely put me in a higher tax bracket. I still have tax deferred savings, but the majority goes to Roth.

    I recognize the potential for a type of national sales tax or flat tax in the future, but I also don’t foresee the complete elimination of additional taxes on the wealthy….and I plan to be wealthy:) I just don’t think our society will be ready for it anytime soon.

    At the end of the day, I’ll keep looking for ways to spend less and save more for the future.

  6. Of course they could change the rules. The easiest would be to use the Roth income as a Modified AGI to implement phaseouts of deductions, set tax brackets, etc.

    They did this with foreign earned income – started treating the exclusion as the first dollars earned and push the other dollars into a higher tax bracket.

    Example: Withdraw $100,000 from your Roth plus earn $10000 in a job or SS benefits. Tax the 10K at 35%, because that’s the marginal rate.

  7. While I tend to think that the gov’t would not be willing to change things on promises made concerning the funding of Roths, your discussion validates the necessity of having money in a number of different buckets to avoid depending completely on a single scenerio.

    I suggest a bucket for Roth funds, another for 401(k)/traditional IRA funds, another for non qualified funds etc. Then my hope would be that we could better orchestrate the tax consequences of our retirement years.

  8. My thoughts are similar to Marks. I anticipate that at some point they will not directly tax your Roth but they will include it as a basis for your tax bracket. So any additional income above and beyond your yearly Roth payout (earned income, capital gains, etc) will be taxed at a higher marginal tax rate.

  9. I agree with Mark and BG. I think that the tax will be nefarious and hidden. Along with their ideas, I see cost of living adjustments reduced or eliminated on social security, VAT taxes, carbon taxes, higher cell phone/internet/cable/airline taxes, etc.

    Or, we could start to vote out folks who vote for any spending bill that results in deficits. That would slow the tax train down a bit…at least until the unfunded Medicare and Social Security liabilities show up at the end of the decade.

  10. Folks, you can call it whatever you wish (like that old commercial) but there is no doubt in mind that Roth distributions will eventually be somehow used to increase tax revenues. There are numerous ways to do this, some have been mentioned by previous posters. Our govt. has changed tax laws often enough over the years and with the looming fiscal cliff rapidly approaching, they will hurt us with higher taxes.

  11. I do think they will be taxed. What will be the easiest to tax that won’t cost the most votes. The tax hikes will go up as follows if we can’t reduce spending: Bush tax cuts expire some of the lower rates may stay the same but the highest rate is going up to 39.5 %, the cap gain and dividend rates are going up too, probably somewhere between 20-30 percent. The estate (death) tax will go up too. Then the 3.8 tax on unearned income will start in 2014.

    I am all for a progressive system but I don’t care how much you make you should pay some federal tax even if it is 5% lets say starting at 5000 of earned income.

  12. I agree with all of you. They have already been kicking ideas around. One of the ideas was to keep your retirement in a government fund (AKA government confiscation) in order to keep your funds “safe”, just like they kept SS safe I’m sure. For the first people it will be nice and the for us young guys we’ll be screwed. Time to follow the Declaration of Independence and have a peaceful revolution, this time…violence isn’t much fun.

  13. Everyone is freaking out here. Roth IRA’s will remain tax-free, mark my words.

    “The policy decision to tax social security benefits was on very different grounds. Congress never enticed people to enter the social security system with the promise that benefits would be tax free. There wasn’t a bait and switch. The initial decision was to create a safety net and not tax the benefits; later Congress decided that people at certain income levels should pay tax on part of the earnings. That’s very different from reneging on a promise to leave earnings free of tax.

    From time to time, Congress has changed the law to cut back on benefits of various types of retirement plans. These changes have generally been accompanied by generous transition rules to protect those who relied on prior law. Similar treatment seems likely if Congress decides at some point to cut back or shut down the Roth IRA.”

  14. @Travis: The Greeks probably also thought nothing would change. In fact, judging from their recent strikes against possible change, they still hope there will be no change.

    Now that Greece has taken EU/IMF money, they will be forced to make drastic changes. Some people will experience the unthinkable – cuts to their entitlements, tax on the previously sacrosant untaxable, etc.

  15. #13 Travis) I agree that a straight up bait-n-switch to tax Roth as income would never happen — but there are other ways: like a federal sales tax / VAT…

    For me, Roths provide zero value, and at an increased risk. Thankfully I’ve read a bunch of blogs on this subject to convince me to abandon Roths.

    JLP) A while back you mentioned you were going to do an email interview with a Roth expert, is that still going to happen?

  16. My strategy for IRAs:
    1. When my income was low, I used traditional deductible IRAs.
    2. When my income increased, I didn’t qualify for the deduction, so I invested in the Roth.
    3. When my income exceeded the Roth limits, I invested in a non-deductible IRA only in years that I needed to increase my holdings in bonds.

    This gives me:
    1. Trad Ded: Immediate tax deductions, at the risk of later paying the higher income tax rate (versus cap gains rate).
    2. Roth: Promise of no future taxation, with the risk of changes in the rules.
    3. Trad non-ded: Defered taxation, and the possibility of withdrawal when my tax rate is lower (if it ever is!)

    This seems like the best way to optimize. When I started my first IRA, there was no choice – they were all “traditional”. If I were starting now, in a low bracket, and choosing between Roth and Traditional, I MIGHT use the Roth more, paying tax now with the promise of tax-free growth.

  17. Great conversation you have going on here. I think on the safe side, it would be foolish to think we would never pay taxes in our lifetime.

    Now as far as Roth IRAs goes, we do need to be more active in our voice with our government, making sure that the government understands the implications of what they are saying. Maybe just a flat rate on Roths, 10 percent or something like that and make it permanent.

    After all, the country was founded on the concept of entreprenualism which means investors and we should be rewarding those who invested in America.

    What I find funny is that they may change the tax laws regarding Roths and then change it again later when 2045 comes around (my retirement years) so I guess it all comes down to growing as much as possible to cover taxes during withdrawal while still having income left over.

    It would be great to hear what your proposal on this topic be.

  18. So if they’re going to tax us on our Roth’s, we would be double-taxed, at the front end and at the back end!

  19. I’m not terribly concerned about all Roth IRA distributions eventually being subject to FIT; after all, our contributions are after-tax. The day the Feds tax basis is the day I stage a revolt.

    However, the Feds could very well decide on a surtax on earnings once distributed; of course, there would likely be a similar surtax on regular IRAs. So, in that regard, I still favor Roth IRAs in that I lock in the rate paid on my basis now.

    I am also concerned about the possibility of a VAT or a national sales tax, but that is something out of our control.

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