Unspoken Risks In Using A Roth

[MasterBlaster]

Joe Bert - in the linked article says it better than I ever could.

In the more-taxes scenario, it is not too farfetched to believe that Congress will institute some form of means testing on the billions of dollars that have accumulated tax-free in the Roth accounts. Now you say, how could they do that? And the answer is, the same way they did it with Social Security. This is my biggest worry

http://finance.yahoo.com/news/roth-just-wolf-sheeps-clothing-230001269.html

I personally have some Roth accounts but wonder if they'll be taxed again going forward.

I just don't trust big GOV to do the right thing when they start hunting for more money to spend on their unfunded liabilities.

 

[pb4uski]

What poppycock!

If people eschew Roths and save tax-deferred as this guy suggests then HE and his financial planning colleagues have more AUM and therefore earn more income.... I wonder why he would be motivated to write an article like this?

Is there a chance that Congress might renege on Roth.. perhaps, but the more money in Roths then the more politically unpopular that would be so the more unlikely it would be.

 

[samclem]

Joe Bert - in the linked article says it better than I ever could.



http://finance.yahoo.com/news/roth-just-wolf-sheeps-clothing-230001269.html

I personally have some Roth accounts but wonder if they'll be taxed again going forward.

I just don't trust big GOV to do the right thing when they start hunting for more money to spend on their unfunded liabilities.

No one knows what will happen, but taxation of Roth IRAs (especially indirect taxation--increasing taxes on other areas in response to Roth withdrawals, or using Roth withdrawals to determine tax bracket, even if not taxing the withdrawals themselves) are a possibility. That's one reason I will be conservative with Roth conversions, keeping a chunk in tIRAs so we can manage withdrawals whichever way things morph in the future.

 

[ziggy29]

I do believe it is reasonably possible that at some point in the future Congress may decide to take away the continued ability to contribute to Roth-style investments. (Not necessarily extremely likely, but possible, yes.) I think it is highly unlikely that existing Roth balances and withdrawals will be taxed, though, for much the same reason why it's very unlikely that anyone over age 55 will be asked to share any of the sacrifice in Social Security reform.

The usual "fear" I hear is that at some point the US would move away from federal income tax and more toward a VAT or a national sales tax.

In the end, we have no idea so it's always good to not only diversify the assets in your portfolio, but also the tax status of the portfolio as well -- traditional IRA/401K, Roth investments, taxable asset accounts. Having significant accumulations of all three maximizes your flexibility in terms of adapting to changes in future tax law to *legally* engineer withdrawals in a way that is most advantageous.

 

[Options]

Kitces did an excellent post in 2014 on the current and possible future(s) of tax reform:

https://www.kitces.com/blog/why-a-roth-conversion-may-be-a-bad-idea-even-if-taxes-are-higher-in-the-future/

Specifically:

the reality is that some of the greatest drivers to our projected future deficits are attributable to Social Security and Medicare, which at this point are primarily funded via payroll taxes that apply to wages but not to IRA distributions. Accordingly, we could “solve” our Social Security shortfall by increasing the payroll tax by 2.72% of taxable wages (effectively taking the Social Security tax rate from 12.4% to approximately 15.1%) and similarly resolve the Medicare shortfall by levying another 1.11% tax on taxable payroll; while these tax increases would have a significant economic impact, and would result in a higher tax burden for some, they would again not lead to higher income tax rates on future IRA withdrawals (as those taxes apply only to employment income).

and

it seems likely that at some point, tax reform will come, and whether in the reform itself or as a part of changes to Social Security, Medicare, and/or the introduction of a VAT, there is a strong likelihood that it will involve a greater future tax burden. But it’s crucial to remember that a higher future tax burden does not necessarily mean higher marginal tax rates in the future… and for those who do seek out conversions, at the least be very cautious about doing Roth conversions in the upper 33%+ tax brackets when most tax reform proposals today have a top rate no higher than 27%! But in the end, the best course of action for most IRA accounts may actually be to wait for the tax “increases” to happen, and do the withdrawals or Roth conversions then, when the marginal rate may be lower!

Emphasis added

 

[growing_older]

It's likely that sooner or later the rules may change. But that doesn't mean you should pass on the advantages of the Roth because you are fearful of a future rules change. At various times people have proposed all kinds of extreme taxing schemes, but that doesn't mean that you should hide all your assets in untraceable forms and bury them in the backyard.

Maybe in the future there will be a VAT, so spending the Roth money will get taxed somewhat. If that happens it's still likely to be to your advantage to have sheltered in the Roth as long as you could. Similarly, some kind of RMD scheme might be implemented to force money out of Roth account eventually. Likely this would also be a case where being tax-free for as long as you are able is still better then not, even if you don't get to be tax-free as long as you might have preferred.

All in all, there's a lot to be said for having options. With some money in Roth accounts, some in Trad IRA accounts and some in plain taxable accounts you won't be optimized for whichever option turns out to be better than the others, but you also will have choices as rules may change and can optimize somewhat under your own control.

I cannot see failing to use Roth (a fantastically wonderful tax advantaged account) simply because you fear the rules could change in the future.

 

[NW-Bound]

Remember that money in Roth accounts is funded with after-tax money. The only difference between Roth and an after-tax account is that earnings and cap gains inside a Roth are not taxed.

So, they may renege and now tax that earning, but that is no worse than your taxable account.

 

[MasterBlaster]

What poppycock!

If people eschew Roths and save tax-deferred as this guy suggests then HE and his financial planning colleagues have more AUM and therefore earn more income.... I wonder why he would be motivated to write an article like this?

The point of the article is valid. There is an implied trust issue in a Roth that those accounts will not be taxed again.

Do you feel lucky ?

 

[pb4uski]

Yes, I do.

Any other silly questions?

 

[Options]

...
I cannot see failing to use Roth (a fantastically wonderful tax advantaged account) simply because you fear the rules could change in the future.

I completely agree and intend to proceed with Roth conversions for the next ten years paying at most approx. $600. tax for a couple of years. In my case, my current high level of tax diversification is working to my advantage in living off of taxable and after-tax while doing the conversions.

All we can do is act according to today's tax parameters while sleeping with one eye open.

 

[NW-Bound]

Here's what one should do. Put money in Roth or do conversion as usual.

When Congress talks about taxing the gains of a Roth account - remember that the principal is already taxed - you rush to cash it all out tax free. Your gain up to that point is still untaxed. You will only lose the tax on future gains after that point.

 

[samclem]

Here's what one should do. Put money in Roth or do conversion as usual.

When Congress talks about taxing the gains of a Roth account - remember that the principal is already taxed - you rush to cash it all out tax free. Your gain up to that point is still untaxed. You will only lose the tax on future gains after that point.

But nobody is now keeping records on the cost basis for Roth money--neither the account holders nor the custodians have that. So, if there's to be a tax, there's no reason to believe it will be on just the earnings (because there's no practical way to know that, or enforce it). People have done withdrawals from their Roths, they've traded funds lots of times, reinvested gains--I don't think there's any practical way to know if gains were already withdrawn or if it was principal--it's all commingled.

I'd think it more likely that the law "keeps the promise" by not taxing any Roth withdrawals. But, instead, the amount of those withdrawals (principal and any gains--makes no difference) is added to other income to determine the individual's tax rate, to determine how much of their SS payments are taxable, to determine ACA subsidies, to determine eligibility for various other subsidies and assistance, tax bracket for Cap Gains and Dividends in taxable accounts, etc. So, the Roth withdrawal was never taxed, it just caused your other taxes to go up. That counts as "keeping the promise" in DC.

 

[pb4uski]

For God's sake samclem, don't give them any ideas.

 

[Ed_The_Gypsy]

The most serious threat to Roths I have run across is requiring RMD s for them. This was floated by the President earlier this year.

Sent from my SM-G900V using Early Retirement Forum mobile app

 

[kaneohe]

But nobody is now keeping records on the cost basis for Roth money--neither the account holders nor the custodians have that. So, if there's to be a tax, there's no reason to believe it will be on just the earnings (because there's no practical way to know that, or enforce it). People have done withdrawals from their Roths, they've traded funds lots of times, reinvested gains--I don't think there's any practical way to know if gains were already withdrawn or if it was principal--it's all commingled.

...............................................................................

Some do and all should keep track of Roth contributions and conversions . When you withdraw funds, you are asked to report it on F8606 and compare it to your contribution and conversion basis. Withdrawals are counted as contributions first, then conversions, and finally earnings so it should be simple with some basic recordkeeping. Trading funds and reinvesting gains does not matter and does not need to be tracked.

 

[samclem]

Some do and all should keep track of Roth contributions and conversions . When you withdraw funds, you are asked to report it on F8606 and compare it to your contribution and conversion basis. Withdrawals are counted as contributions first, then conversions, and finally earnings so it should be simple with some basic recordkeeping. Trading funds and reinvesting gains does not matter and does not need to be tracked.

So, LTCG, STCG, dividends, interest, etc in Roths would have to be taxed at the same rate (just "gains"), right? There's surely no way to tease all of those apart again.
Anyway, using Roth withdrawals to cause increased taxationof other income seems more politically palatable--"we kept our promise".

 

[MooreBonds]

Joe Bert - in the linked article says it better than I ever could.

I personally have some Roth accounts but wonder if they'll be taxed again going forward.

I just don't trust big GOV to do the right thing when they start hunting for more money to spend on their unfunded liabilities.

There have been numerous times that I have repeated the exact same thoughts this author has - that the gov't likely WILL hit up ROTHs. If they got away with double-taxing SS payments up to 30%, they can get away with anything. That is why I always suggest diversification in taxation as well as investments - so if we go with a consumption and/or ROTH tax, people won't be stuck wishing they had a 50:50 mix of ROTH/taxable, rather than everything in 1 account type.

Kitces did an excellent post in 2014 on the current and possible future(s) of tax reform:

https://www.kitces.com/blog/why-a-r...-idea-even-if-taxes-are-higher-in-the-future/

Specifically:

the reality is that some of the greatest drivers to our projected future deficits are attributable to Social Security and Medicare, which at this point are primarily funded via payroll taxes that apply to wages but not to IRA distributions. Accordingly, we could “solve” our Social Security shortfall by increasing the payroll tax by 2.72% of taxable wages (effectively taking the Social Security tax rate from 12.4% to approximately 15.1%) and similarly resolve the Medicare shortfall by levying another 1.11% tax on taxable payroll; while these tax increases would have a significant economic impact, and would result in a higher tax burden for some, they would again not lead to higher income tax rates on future IRA withdrawals (as those taxes apply only to employment income).

But that's patently FALSE. If you or I contribute money to a 401k or traditional IRA, that money HAS ALREADY HAD FICA payroll taxes paid on it. Our SS/Medicare bases have not been reduced by the amount of the contributions to traditional IRAs/401ks.

So if our traditional IRAs/401ks have a SS tax rate applied to withdrawals, then this is yet more double taxation.

 

[kaneohe]

So, LTCG, STCG, dividends, interest, etc in Roths would have to be taxed at the same rate (just "gains"), right? There's surely no way to tease all of those apart again.
..............................................

correct...the "gains" or earnings would be taxed, if they are taxed at all, at ordinary income rates w/ possibly penalties depending on when they are taken out.

 

[growing_older]

correct...the "gains" or earnings would be taxed, if they are taxed at all, at ordinary income rates w/ possibly penalties depending on when they are taken out.

Whoa, whoa, whoa.

There's no "correct" about it. You are merely speculating about details of rules that have not yet been written for a concept that hasn't been raised for a future tax modification that hasn't been drafted, or in fact seriously discussed, anywhere other than in speculative articles looking for click-audience. This isn't even vapor. It's fantasy. Impossible to rule out, but way too far from reality to seriously discuss.

 

[Texas Proud]

Yea, I will duck and cover after this post...

They can always tax the withdrawals at a fixed 10% or 15% and not really care what part is cap gain or anything else...



I also do not think there will be a VAT... that is one that would more than likely die on the vine.... never say never, but the rate that they would likely impose would be high and they would be voted out on the next election with a promise of repealing that tax.... you think Obamacare is not liked... wait until a VAT tax is passed....

 

[thefinancebuff]

I'd think it more likely that the law "keeps the promise" by not taxing any Roth withdrawals. But, instead, the amount of those withdrawals (principal and any gains--makes no difference) is added to other income to determine the individual's tax rate, to determine how much of their SS payments are taxable, to determine ACA subsidies, to determine eligibility for various other subsidies and assistance, tax bracket for Cap Gains and Dividends in taxable accounts, etc. So, the Roth withdrawal was never taxed, it just caused your other taxes to go up. That counts as "keeping the promise" in DC.

Just like muni interest, tax free, but it's included to determine MAGI for Social Security, ACA tax credit, and maybe something else.

 

[Senator]

Unless you have more net worth than the average member of congress, I do not think it will ever affect you.

 

[mpeirce]

The most serious threat to Roths I have run across is requiring RMD s for them.

+1

I actually expect this at some point.

The other threat to a ROTH is some sort of consumption tax. I doubt they'll call it a VAT, but a national sales tax applied to certain products (carbon tax anyone?) is another way to raise taxes.

I actually support a consumption tax, IFF we eliminated the income tax. The real danger is adding consumption taxes while keeping the income tax.

 

[kaneohe]

Whoa, whoa, whoa.

There's no "correct" about it. You are merely speculating about details of rules that have not yet been written for a concept that hasn't been raised for a future tax modification that hasn't been drafted, or in fact seriously discussed, anywhere other than in speculative articles looking for click-audience. This isn't even vapor. It's fantasy. Impossible to rule out, but way too far from reality to seriously discuss.

Sorry if it wasn't clear to you (and the site doesn't help because it doesn't quote the entire post being quoted)........this is existing law for withdrawal of earnings from Roths.

 

[LOL!]

OK, if one accepts that there are risks to Roth money, what does one do?

A Roth is still one of the best places to avoid taxes: Contribute to a Roth without paying taxes and withdraw from a Roth without paying taxes. What's not to like about that? (And if you have to ask me how does one contribute to a Roth without paying taxes, then you are still working.)