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?
Before we explore possible answers, let’s 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, at which point your beneficiaries may receive them, tax-free (except for possible estate taxes).
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 will be on the hook for paying taxes on those assets 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 main reasons.
Politics. The demographic that boasts the highest amount of voter turnout is age 60+. Not coincidentally, the 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 Roth 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).
Saying sayonara to the Stretch IRA
A stretch IRA isn’t actually an IRA at all. It’s a strategy that allows IRA account holders to pass along their wealth over several generations—in essence, “stretching” the IRA across their beneficiaries. 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 $3.4 million
Congress could consider enacting a law that prevents Roth IRA account holders with more than $3.4 million in their Roth from making any further contributions to it.
Locking down back-door Roth conversions
As mentioned earlier, high earners are ineligible to contribute to a Roth. But (at least for now) there’s a loophole for them: they can put money into a traditional IRA, which has no income limits, and then convert it to a Roth. People who do back-door Roth conversions do have to pay taxes on the money that they move into the Roth—ouch. But the conversion can also be done over a number of years to minimize the tax impact. However, Congress may eventually close this loophole.
In the meantime, the Roth IRA remains a very attractive savings option for most 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.