Since the Roth IRA was created in 1997, a portion of the financial services community warned the Roth IRA was a trap. Congress would wait until Roth accounts held trillions of dollars, then repeal all or some of the tax benefits.
From the start, I’ve been skeptical of the arguments that Roth IRAs are a trap and encouraged taxpayers to use them. I think there’s even less reason today to fear that there’s a Roth IRA trap.
Life insurance and annuities have maintained their tax advantages for many decades despite academic and political arguments against them. That’s because insurance companies have good lobbying and many consumers now rely on the benefits of the products.
Roth IRAs have the same advantages. Mutual funds and brokers are custodians for Roth accounts that hold a lot of money. These financial services companies have good lobbying organizations. Plus, a lot of consumers have Roths as part of their financial plans and would object to repeal of their benefits.
More importantly, recent laws and proposals indicate that Congress likes Roth accounts. That’s because people who use Roth accounts pay their taxes now.
When traditional IRAs and 401(k)s are used, people receive tax breaks today and don’t pay taxes on their accounts until the future, often many decades in the future.
There are trillions of dollars sitting in traditional retirement accounts, and many members of Congress are impatient to receive the tax revenue from distributions of those benefits.
That’s why the SECURE Act of 2019 repealed the Stretch IRA, accelerating taxes on inherited retirement accounts.
It’s also why a few years after the Roth IRA was created, Congress repealed the rule that taxpayers with incomes above $100,000 couldn’t convert traditional IRAs to Roth IRAs. Congress wants people to convert traditional IRAs to Roth IRAs, so the government can collect taxes now instead of later.
The SECURE Act 2.0, enacted at the end of 2022, contained several provisions that encourage people to use Roth accounts. In recent years, some members of Congress have proposed phasing out traditional retirement accounts in favor of Roth-type accounts.
My only fear about taxes on Roth accounts is that Congress might do to Roths what it did to tax-exempt bond interest.
Interest on state and local government bonds still is not included in gross income. But tax-exempt interest is added back to determine the modified adjusted gross income that is used to compute the Stealth Taxes.
Stealth Taxes include the tax on Social Security benefits, the Medicare premium surtax, the 3.8% net investment income tax, and others.
I think the main risk is that, at some point, Roth distributions are included in modified adjusted gross income to compute the Stealth Taxes. The Roth distributions wouldn’t be subject to income taxes, but they would be used to increase the Stealth Taxes. That’s not the law now, and I haven’t seen anyone in Congress propose it. But I think it is the greatest risk to the tax-free status of Roth IRAs.
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