Roth IRAs in 2010: Beneficial or Beware?

What hath Congress Roth?… or better yet, what will they Roth in the future? You’re right, terrible attempt at a pun.Roth IRAs In 2010:  Beneficial or Beware? In case you aren’t a retirement and financial planning geek like myself, there has been a proposal put forth by the current administration to require all employers to automatically enroll employees in a retirement plan.  I find it interesting that the choice for a “default” retirement plan for the proposed system is a Roth IRA. The reason this is so interesting is because a Roth IRA doesn’t provide the participant with an immediate benefit – there is no tax deductibility, no employer match, etc..  Granted, any sort of retirement savings is a good idea, but this type of plan will be a hard sell for those folks who haven’t already bought into the concept of saving strictly for the benefit of saving on their own. In addition, there’s the current push (in 2010) for lots and lots of Roth conversions.  This one is even better – there’s not only no adverse tax revenue consequence, there’s a great tax revenue advantage if lots of IRA money is converted and taxed. This push has been referred to as a “mortgaging of the future” – since we’ll get lots of tax revenues from the conversions today at the expense of future revenues on the growth in the accounts. It wouldn’t be hard to imagine a future administration pointing to 2010 as the first domino that caused the soon-to-be current circumstances.

Is there more to it?

Perhaps there is more to it – obviously, a dramatic increase in participation in deductible IRAs could have a significant negative impact on tax revenues, hence the Roth being recommended as the default.  But what if Congress decides at some point down the line that this Roth deal looks too good for the taxpayer??  What if the idea of completely tax-free distributions starts to cause extreme anxiety among our legislators (as un-taxed benefits often do)? It’s quite possible that the reason the Roth IRA account has been deemed the plan of choice is primarily because of the non-existent tax impact in the short run.  And the longer-run consequence (the mortgage of the future) of potentially locked up funds that will bring no tax revenues can be dealt with by future administrations – when such tough decisions can be confronted far distant from the decision-makers who helped us to get into the position in the first place. Another thing that’s pretty interesting is the fact that many of the online Roth Conversion calculators are reportedly over-stating the benefits of Roth Conversion – putting far more emphasis on the potential for future higher tax rates and the benefits of no RMDs than is warranted.  It’s not hard to guess why asset-gathering companies might suggest that it would be in your best interest to convert assets to Roth IRAs; conveniently under the management of the company who recommends conversion. Imagine the case in 20+ years when a great amount of the wealth in this country is locked up in Roth IRA accounts – with no tax ever to be paid on it (under current law), and no Required Minimum Distributions (RMDs) of the funds.  I can imagine that there might be an “emergency needs-based” change to the law – perhaps something simple like a requiring RMDs, with maybe a value-added tax, along with possibly inclusion of Roth IRAs as taxable assets in your estate.  That would pretty much knock all these conversion schemes on their collective ears, don’t you think?

Your Defense

It is for these reasons that I believe most folks are best served by not putting too many eggs in one tax treatment basket – you should not only have traditional IRA or 401(k) assets along with Roth IRA or 401(k) assets – you should also have taxable savings, such as a standard brokerage account and/or savings account.  By diversifying your savings across multiple tax treatments you can hedge your bets against whatever adverse changes there may be for the future. In addition, cast a wary eye toward any recommendation for conversion to a Roth IRA – make sure that this makes complete sense to you, both from a tax payout standpoint today, and from the point of view of what you know and expect about future tax rates and laws.  Most importantly, don’t take advice strictly from someone who stands to benefit from the very advice he’s giving.  Don’t take this to mean that Roth IRA conversion isn’t ever beneficial: for many people there are compelling reasons to convert at least some assets to Roth.  It just makes good sense to proceed with caution and make no swift, dramatic changes. And pay attention, because these things have a tendency to happen so subtly that you might even think it’s a good idea…
Photo by Rennett Stowe

About the author

Jim Blankenship, CFP®, EA

Jim Blankenship is the founder and principal of Blankenship Financial Planning, Ltd., a financial planning firm providing hourly, as-needed financial planning and advice. A financial services professional for over 25 years, Jim is a CFP professional and has earned the Enrolled Agent designation, a designation that qualifies him as enrolled to practice before the IRS. Jim is also a NAPFA-registered financial advisor, which designates him as a Fee-Only Financial Advisor.

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