Roth and the "Tax Free" concept

I see a lot of folks on this NG who keep talking about converting their IRAs to Roth IRAs touting the Roth being tax free on the back end as one of the big reasons to do this. The problem is that the Roth isn't really tax free, it's Tax DEFERRED - at least for the moment. It is SUPPOSED to be tax free when you take the money out in retirement, but if you break the rules it implodes.
We also need to keep in mind that to get into the Roth we FIRST have to pay taxes on the money going in - whether its on current contributions or conversions, the tax has to be paid. It is only the GAINS that come out later with some tax benefit.
But here's the wild card - how certain are we, considering the current economy, the financial crush that the states are under (with California issuing IOUs instead of refunds, with Alabama defaulting on 529 prepaid college plans, and with the continued and constant expansion of the Feds) that Congress won't change its mind and decide they now need to tax the earnings from Roth accounts?
After, this is what's happened to Social Security Benefits - there were not taxed from inception (1936?) until 1981, less than 50 years. Also, rental income was never subject to S/E tax, but they're considering that now - along with a special Medicare tax on investment and portfolio income and a special tax on the sale of a home.
So while we like to THINK that the money is a Roth is tax free, it is really only tax deferred. If it gets removed early or if the rules change then it won't be tax free.
Personally and professionally, I fully expect Congress to reverse direction (they need way more money then they have now and the don't seem interested in doing anything to stop the bleeding) and tax the growth in Roth IRAs. In fact, I predict that eventually Roths will get the same treatment as today's nondeductible traditional IRAs - taxed on the growth as its removed. I don't know exactly when this will happen but I expect it will be in the next 10 to 15 years, perhaps sooner.
The only folks who'll get tax free money from a Roth are the one's taking it out NOW.
Gene E. Utterback, EA, RFC, ABA
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Gene E. Utterback, EA, RFC, AB
You may be right, but if you look at Greece, France, and England (probably a few more like Spain and Portugal) the reverse direction is ... austerity in the form of budget cuts.
I'm not an authority on this, but I did read that the overall optimal level of taxation / stagnation is around 17% taxes / GDP. Congress knows this, and they know that the current deficits are unsustainable. We have had surplusses in this country before. Why not again? Why not always? Why not make that normal, like it SHOULD be? It is stimulative to the economy when everything is going well - confidence goes up. Cutting government reduces inflation - which we may see in coming years.
One arson fire doesn't mean the whole town is doomed. The cops get on it. In this case, we ARE the cops, and we have an election coming up.
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"Gene E. Utterback, EA, RFC, ABA" writes:
Chances are they may do so in a stealth way. For example, similar to how they handle MAGI - take your AGI and add stuff back, then use the MAGI to figure out if you qualify for various things, or if you start running into phaseouts of other things, etc.
But it seems unlikely that they would simply tax it at your regular marginal income tax rate.
There are other similar ugly things they could do and still get away with claiming that they are sticking to the promise to not tax Roth distributions. You suggested another below - the "special Medicare tax" that ObamaCare is introducing for the first time on investment income could certainly be extended to include Roth distributions.
There's no reason to think that if they attack Roth distributions that way, the same attack would hit regular IRA distributions, especially if it's done in the manner of that Medicare tax. So are you better or worse with the Roth? In that case, still better.
I don't see them taxing the entire growth at regular marginal income tax rates. I think the blowback would be too hard. Congress will need some sort of cover to claim that they are not taxing it as regular income. It'd have to be through stealth (ie. add back into MAGI, thus forcing things like greater amounts of folks SS income to be taxable, etc) or a surtax on all IRA distributions.
Plain Bread alone for e-mail, thanks.  The rest gets trashed.
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I would stay diversified with forms of retirement eggs (roth + trad ira + mattress money + maybe a gold coin) just to cover present and future regulatory pitfalls.
Arghh, I wasn't aware of that tax, which is apparently slated for 2013. Maybe then muni bonds will offer a better alternative. Keep in mind calendarwise we also have potential bulges in roth conversion tax liabilities 2010 OR 2011+2012 based on a one time choice offered only for a few more months.
Furthermore, we have potential tax rate increases after 2010, so for that and possibly a roth deferral and medicare slamming the 2011++ period, maybe 2010 is the time to "wash" any capital gains during this year. I notice many brokers are offering commission free etfs (a handful in fidelity, a hundred in ameritrade, maybe some in schwab?) so it may be worthwhile converting any above-water investments into them (enough choice to avoid literal "wash" sales).
Here's a crazy idea to try to profit from rather than just suffer dysfunctional gov't whimsy. They are pushing expensive and farmland- killing biofuels instead of abundant and clean natural gas (maybe because more farmers vote or lobby than gasfield owners - gives hope for voting roth holders). So short gas (UNG) or go long biofuels (FUE). Or even more, consider how PC biofuels are squeezing farmland now needed for basic necessities of life in upwardly mobile emerging nations, such as sugar (SGG) and cotton (BAL).
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shows their spectacular trajectories in doubling or halving in short periods of time. Maybe just observe rather than participate in such trends until you become comfortable (trends might be violently upset in next week's events), but just shows how you can surf gov't nonsense rather than just suffer from it.
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I agree with your warning, but for other reasons.
The statement "I think my taxes will be higher at retirement" doesn't match with the statistics of how little most people save. In today's dollars, to retire in the 25% bracket would take nearly $2M in assets.
Second (false) assumption is that one will be in their current or higher rate right till retiring. No chance of a low income year? Lost job? Spouse stays home? Etc.
Last - the move to a wholesale conversion which throws one into a higher bracket defeats the whole intent. Those talking about converting these huge numbers should take a step back, do the math, and just convert to top off their current bracket.
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I believe it's best to plan using the tools available now. Qualified withdraws from a Roth are tax free (right now). If the rules change, it is very possible the rules would be in effect "starting Jan 1 201x" so anyone wanting a tax free withdraw should take their money out "Dec 31 201x -1) Meaning the day before the new tax is in effect. If withdraw is qualified, under current rules, its tax free. Unless congress makes the tax retroactive (meaning passes bill tomorrow taxing the money from 10 years ago or passing bill next week taxing all distributions from Jan 1 2010 forward), most people with money in a Roth could see it coming and take appropriate action.
If the mutual fund industry sees this coming, you better believe they will lobby against it (the mass withdraws from Roths would probably cause some issues with the market).
Do the mutual fund companies provide information which states if they have $5 billion in assets, how much of those $5 billion assets are in 401k vs Roth vs taxable brokerage accounts?
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Yes, no link handy, but I've seen many articles that show total 401(k), IRA, Roth US account totals. Joe
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