Will Roth IRAs Ever Be Taxed?
If you hang out long enough on personal-finance discussion forums, you’re bound to see this question posed: Will Congress ever repeal the Roth IRA?
But before we explore possible answers, let’s first review the features and benefits of the Roth.
Roth IRA Basics
The Roth IRA was created in 1997 by Senator William Roth of Delaware. Anyone with earned income (regardless of age) may open a Roth.
Like a traditional IRA, the Roth offers tax-free growth potential. But that’s where the similarities between the two accounts end.
Contributions to a Roth are made on an after-tax basis. That means you won’t reduce your current taxable income if you put money into a Roth.
For 2019, the maximum Roth contribution is $6,000 ($7,000 if you’re 50 or older).
You may not be eligible to contribute to a Roth if your income is above a certain level. This year, eligibility starts to phase out at $122,000 for single tax filers and $193,000 for married people filing jointly.
Withdrawals of your Roth contributions are tax-free, no matter when you take them. You won’t pay a penalty on them, either. But you’ll have to pay taxes (plus an early withdrawal penalty, in some cases) if you withdraw earnings from your Roth.
If you are at least age 59 1/2 and have owned your Roth IRA for at least five years, you can withdraw both your contributions and their earnings tax-free and penalty-free.
There are some withdrawal situations (first-time home purchase, permanent disability or death) which are exempt from taxes and/or an early withdrawal penalty.
Roth IRAs have no required minimum distribution when you turn 70 ½. If you don’t need the assets in your Roth, they can sit there until you die (growing tax-free), at which point your beneficiaries may receive them.
Let’s say you get a part-time job after you officially retire. In that case, you can keep contributing to a Roth—as long as your income stays within the eligibility limits.
What if Congress makes Roth IRAs taxable?
Despite the Roth’s fantastic features, some people avoid opening one. They worry that someday, Congress may repeal the Roth’s tax-free withdrawal benefits. If that happens, Roth owners may potentially be on the hook for paying taxes on the growth when they pull them out.
Can it happen? Absolutely. But will it happen? While that’s anyone’s guess, most financial professionals agree it’s unlikely, for two reasons.
Politics - The demographic that boasts the highest amount of voter turnout is age 60+. That same group would be most affected by a potential Roth repeal. It’s not hard to believe that older voters would vigorously push back against any politician who supported such a proposal.
Economics - Investing supports economic growth. Stock buyers become part-owner of companies they invest in, while bond investors become creditors to the companies whose bonds they buy. Retirement plans, including the Roth, are one of the most common ways that Americans invest. If the government took away the Roth’s tax-free withdrawal feature, it would provide one less avenue for people who want to invest. And fewer investors could lead to slower economic growth. So, it’s not a stretch to say that protecting the tax advantages of the Roth is in the best interest of our economy…and the government knows it.
Will today’s Roth IRA always look the same?
It’s hard to tell. Some financial professionals admit that, while the actual Roth itself is in no danger, some of its features may change over time. These potential changes could include:
Adding a minimum distribution requirement at age 70 ½
Congress could require original Roth account owners to take minimum distributions once they reach age 70 ½ (similar to the required minimum distribution (RMD) rules governing traditional IRAs and 401(k) plans). While this doesn’t create taxes through the distribution itself (as Roth distributions are tax-free), it does pull that money out of the account and curb future tax-free growth.
Saying goodbye to the Stretch IRA
A stretch IRA isn’t actually an IRA. It’s a tax strategy that allows the beneficiary of an IRA account to stretch the annual RMDs over their life expectancy —in essence, “stretching” the IRA distributions. While qualified Roth IRA distributions aren’t taxable, forcing the money out of the account faster over a shorter time horizon would again curb future tax-free growth. Congress could potentially make a rule requiring all beneficiaries to withdraw inherited Roth assets within a certain period of time.
Capping Roth contributions after your account balance hits a certain threshold
Congress could consider enacting a law that prevents Roth IRA account holders with more than a certain dollar amount in their Roth from making any further contributions to it.
Locking down back-door Roth conversions
As mentioned earlier, high income earners are ineligible to contribute to a Roth in the traditional sense. But (at least for now) there’s a loophole for them: they can make a non-deductible IRA contribution (after-tax dollars similar to a Roth), which has no income limits, and then look to convert it to a Roth down the road. It is important to note that IRA aggregation rules would apply when converting to Roth and you should consult with a tax professional to understand the tax impacts of this strategy. But depending on the IRA account mix you have, this could be a very efficient way to fund a Roth. At the moment, there is no income limit for Roth Conversions. However, Congress may eventually close this loophole.
At the moment, the Roth IRA remains a very attractive savings option for many people. It’s especially good for anyone who thinks they will be in a higher tax bracket come retirement. One thing’s for sure: what could happen down the road shouldn’t be used as a reason to avoid contributing to a Roth now.