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Will The Roth IRA Remain Tax Free?

Posted on | April 30, 2009 |

Many financial planners recommend that investors salt at least some of their retirement savings away in a Roth IRA - and with good reason!

Roth IRA Eligibility Rules.

Eligibility rules are simple - if you earned taxable compensation, you are eligible. If you’re eligible, you next need to see if you qualify. For 2009, if your adjusted gross income (AGI) is less than $105,000 when filing single, or $166,000 when filing jointly then you qualify. NOTE: if you earned more than those amounts, you may still qualify for a Roth IRA, but at reduced levels of contributions.

Speaking of contribution levels, for 2009 the maximum contribution is $5,000. Like 401(k)s, there is a catch up clause, but I won’t go into that here.

Roth IRA benefits.

Any qualified distribution (withdrawal) is tax free. A “qualified” distribution is what that occurs at least five years after you first started to contribute to a Roth IRA and after you’ve reached age 59 1/2.

See http://www.money-zine.com/Financial-Planning/Retirement/Roth-IRA-Rules/ for more.

The problem.

The best selling point for most people is the tax free withdrawals, but this may be in jeopardy. Consider the following…

  • Obama’s deficit is projected to be over $10 TRILLION in the next decade.

Now, deficits are not always evil and are sometimes necessary. Personally, I happen to believe that $10 trillion is excessive and dangerous. But regardless of how such deficits make us feel, one fact remains: It will need to be paid back.

The interest payments alone are set to take on a run-away snowball effect right around the time other social programs like Medicaid, Medicare and Social Security are projected to go bust.

In order to pay down this debt, the government will have two basic options: 1) Borrow the money, 2) Increase tax revenues. Borrowing the money is not going to work, not only because it will be difficult to find countries able and willing to lend that kind of cash, but because it would be pushing the deficit around without actually lowering it. This leaves option #2.

The current crop of politicians in Washington will interpret this to mean raising existing taxes and imposing new taxes. Ironically, in doing so they will stifle economic growth further, exacerbating the problem. But that’s another matter…

Higher taxes needed.

Modern Democrats have adopted the “Tax the Rich” mantra as a solution to their runaway spending, but this strategy falls short. First of all, they won’t be “Rich” after they’ve been taxed at the levels required to fund the spending projects. The whole “tax the rich” philosophy is little more than class envy and ignores the fact that most Americans do not remain fixed at any particular income bracket.

Another solution that is often proposed is to apply FICA taxes on all income. Congress has been sliding the maximum up year after year, but for 2009 only the first $106,800 of income is subject to the FICA tax. But even opening up all of a worker’s income to the FICA tax would not produce enough revenue to cover the funding gaps.

Conclusion.

Since there exists no single solution to generating the increase in revenue required to pay for the spending occurring today, and since the Federal Government is unlikely or unwilling to adopt a fiscally responsible policy the likelihood exists that we will not only see increased tax rates, but also an increase of new taxes. Already, politicians have targeted the 401(k) plan. One of their criticism of the plan is the money the Government misses out on while workers funds grow tax deferred. In this light, can we really expect that withdrawals from Roth IRA plans will remain tax free? Never mind that this would, in effect, tax workers twice (once when the earned the money to contribute, and then again when they withdraw their savings).

Well, those are my thoughts on the matter. What are yours?

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