Could the new Congress tax Roth withdrawals?
I’m sure there’s been a thread on this but I can’t find it. Perhaps someone would point me.
Has anyone voiced the possibility of Congress changing the law and adding taxes to Roth withdrawals? I’m in the middle of a multi-year conversion process (converting as much each year as I can and stay under a 30% tax rate) but if Congress adds taxes to Roth withdrawals (they did just do away with the death tax which is a tax on something already taxed) then conversions would not make sense.
KInd regards, James
Permalink Submitted by Alan Spross on Tue, 2009-05-05 20:29
I think this is about the last thing to worry about. The basic characteristic of a Roth contribution is that there is no deduction for the contribution, but the distributions including earnings will be tax free. Anyone making regular or conversion contributions is making them for this reason. The idea of taxing these contributions for a second time or the earnings for a first time would be tantamount to a fraudulent confiscation of retirement funds. If anything, Congress’ need to generate more current tax payments will come with further encouragements for Roth conversions along with such campaigns as ending offshore tax shelters.
If Congress ever decides to seriously address long term deficits, they could conceivably grandfather current Roth accounts and restrict new contributions, but that would still protect the intent of prior contributions. It would also likely increase the value of contributions made in the past, and most people would only wish they had more Roth assets of the grandfathered variety.
You might see further restrictions in attaining Roth qualification, eg taking the 59.5 age up a few years or the holding period increased above the current 5 years. But again, this would not be a retroactive restriction, only a future restriction under which taxpayers would have the chance to determine if they still wanted to contribute or not.
But a blatant bait and switch – I don’t think so, even if certain legislators want to end their political careers.
That said, it is still possible, but rare, to overdo your conversions. For example, paying a tax rate that is likely to be higher than your average rate in retirement does not make sense in most cases. Whatever plan you have should be revisited annually to see if it still makes sense.
Permalink Submitted by James Mitchell on Tue, 2009-05-05 21:51
Thanks for your comforting words! I agree with everything you say. I only raised this question because an investor friend who is normally quite savvy commented to me over the weekend that “Ed Slott is concerned they will be eliminated”. I do not know where he got this. As you point out, however, being eliminated and having the tax basis changed is two different things. It’s time to Charlie Mike re converting as fast as reasonably possible. Sadly, my situation only allows converting $50k/yr before hitting the 30% incremental tax limit.
Regards,
James
Permalink Submitted by Bruce Steiner on Tue, 2009-05-05 22:36
Given the other benefits of the Roth, it may be worth converting even at a somewhat higher tax bracket than would otherwise be applicable to the receipt of the IRA benefits, though not necessarily at a much higher tax bracket than would otherwise be applicable.
Permalink Submitted by Alan Spross on Tue, 2009-05-05 22:56
To add to what Bruce is saying here, one of the situations that could call for converting more aggressively at potentially higher tax rates than the subjective “rate in retirement” is when someone has extensive pre tax retirement assets as well as extensive taxable assets, but very little in Roth accounts. Essentially, this gets at “tax diversification” where it would be unwise to have all your assets subject to future tax rate increases and virtually none to use with the flexibility of tax free distributions without RMDs.
Another way of putting this is to err toward converting when your Roth assets are a very small percentage, and once the Roth assets become a major portion, the bias would shift to erring on the side on leaving more pre tax assets in place. It is still impossible to quantify the point at which the bias should change, but the pain of paying present taxes has so far resulted in taxpayers passing on conversions for the most part. At last count around the end of 2006, only about 5%-6% of all IRA assets were in Roth accounts. The 2010 elimination of income limits and the 2 year deferral available for 2010 conversions will probably result in substantial conversion activity next year, certianly the most since 1998.
Permalink Submitted by Bruce Steiner on Tue, 2009-05-05 23:04
I suspect the main reason that such a small percentage of IRA assets is in Roth IRAs is that thus far, owners of large IRAs have not been eligible to convert because of the $100,000 income cap.
Another reason may be that some owners of large IRAs don’t have enough nonretirement assets to pay the tax on the conversion.
Finally, having spoken on this at many continuing professional education programs (including programs for lawyers and accountants), my sense is that many advisors don’t understand the benefits of the Roth conversion.
Since the $100,000 income cap ends after this year, I think there will be more discussion of Roth conversions later this year and next year, and I think this will result in more Roth IRA conversions beginning next year.
Bruce Steiner, attorney
NYC
also admitted in NJ and FL
Permalink Submitted by James Mitchell on Wed, 2009-05-06 00:51
The tax considerations of this exercise are non-trivial. I do my pre-planning with turbotax; inputting in expected values for the next year and assessing the effects of different scenarios. I have a rather boring situation; roughly $250k in non-qualified, $1,100k in TIRA and $150k in RIRA. I am delaying taking Social Security until age 70.5 (when my Roth conversion window will close) and only have modest expenses creating earned income (from non-qualified stock sales).
Here are the incremental tax rates for different Roth conversions in 2009:
[u]Conversion:[/u] [u]Inc Tax Rate[/u]
0 to $50k: 15%
$53k to 80k: 30%
$80k to $100k: Ramp down to 25%
$100k to $140k: 25%
$140k to $250k: Ramp up to 35%
>259k: 35%
It looks like AMT is kicking in at the circa $50k mark and then goes away at some point.
The lessons from this: 1) AMT screws up lots of normal thinking, 2) It may or may not be beneficial to spread conversions over two tax years.
Does anyone have a different interpretation of this type data?
Regards, James