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No Help for Those Who Need It, a Windfall for Those Who Don't

Roth IRAs Painting the Treasury Red

by GERALD E. SCORSE

Imagine the government pushing a retirement plan that’s guaranteed to raise the federal deficit. Imagine that the same plan inherently favors the already-favored. Far from imagining, you’re describing Congress’s growing embrace of Roth individual retirement accounts (IRAs).  

The lure of Roths is the upfront revenue they bring in. Contributions to Roths are after-tax, unlike the pre-tax contributions to regular IRAs, 401(k)s, and other traditional plans. In fact Roth accounts are costing the Treasury billions upon billions. Let’s see what drives the losses, and why they’ll be climbing far into the future.     

All the money in retirement accounts gets preferential tax treatment going forward. Capital gains grow untaxed, lifting balances year after year. Traditional accounts pay the country back through taxable withdrawals—voluntary starting at age 59 1/2, mandatory at age 70 1/2. The inflows to the Treasury square the books on a win-win bargain: decades of tax-free growth for retirement savings, coupled with decades of growth in downstream tax revenues.

There are no downstream revenues from Roths. Capital gains are permanently tax-free, creating Treasury shortfalls that erase and ultimately far outstrip the initial boost. There are no required distributions (which might at least spin off some revenue). Losses from Roths grow endlessly; the only question is how large the final numbers will be. Such are the accounts that Congress has chosen to promote—most directly to the affluent, whose incomes once barred them from owning Roths.

The red ink has effectively been flowing ever since the accounts were created in 1997. It turned a deeper red when Congress did away with the $100,000 adjusted gross income limit for Roth conversions. These are paperwork transactions that turn regular IRAs into Roth IRAs. To do this, account holders first have to pay the taxes on the converted amount. The tax bill discourages conversions—but for the well-off, not so much. Investment giants Fidelity and Vanguard reported conversion bonanzas when the income limit came off in 2010.

Roth conversions were back again as part of the 2012 “fiscal cliff” budget deal. The agreement opened the door to immediate conversions by 401(k)s and the like; until then, holders couldn’t convert to Roths before age 59 1/2.

Earlier this year, the Republican majority on the House Ways and Means Committee unveiled the most sweeping tax reform plan in a generation. It makes the first direct attack on traditional accounts, and would sharply increase Roth ownership. It would prohibit any further contributions to regular IRAs. It would limit annual contributions to other traditional accounts to $8,750, half the current maximum; contributions over $8,750 would be channeled into Roth accounts. The income limit for start-up Roths would disappear, just as it has for conversions. According to the GOP plan, these changes would raise about $160 billion over the period 2014-2023. The number is just the latest Roth hocus-pocus: the losses would eventually swamp the apparent gain.

It’s good to help workers save for retirement, as traditional accounts have been doing since the mid-1970s. In contrast, Roths are no help for those who need it but a windfall for those who don’t. They cost the Treasury untold billions. They’re also plainly unfair: why should Roths pay taxes only on contributions, while all the other accounts pay on gains as well? Why should the others require distributions, but not Roths?

Howard Gleckman edits TaxVox, the blog of the nonpartisan Tax Policy Center. In 2010, with Roth conversions booming and talk of more Roths already in the Capitol air, he flashed a warning signal: “This infatuation with all things Roth bears close watching.”

The infatuation keeps growing, and the red ink just keeps rising.

Gerald E. Scorse helped pass the bill requiring basis reporting for capital gains. He writes articles on tax policy.   

Notes.

“For stocks, mutual funds and bonds…Congress now requires brokerages to report the basis of these investments, a reform wrought partly after my reporting on this issue and the work of others, including Gerald Scorse, who pressed this issue with lawmakers.” – pp. 271-2 of the David Cay Johnston book, The Fine Print.