Time to Retire the Roth IRA

The day after Congress passed health care, an opponent called it “a fiscal Frankenstein.” In fact those are fitting words for Roth Individual Retirement Accounts (IRAs). Roths are great for holders but grim for America. They’re wired to cost the country billions a year in lost revenue. It’s time to retire them.

Congress created retirement accounts to spur saving for the golden years. Let’s compare Roths to other accounts, and see why they’re fated to drive up the deficit.

In the other accounts, nest eggs grow tax-free until money is withdrawn. Taxable payouts can begin after age 59 1/2. Payouts must begin by age 70 1/2 and continue annually thereafter. The accounts strike a two-way bargain: years of tax deferral, followed by years of tax-paying withdrawals.

Then, in 1997, Congress set up the Roth IRA.

In a Roth, taxes are treated the other way around. There’s no tax break on contributions. From that point on, taxes simply vanish. There’s no taxable required distribution. There’s never a tax on gains. No withdrawals are required. Withdrawals, if any after age 59 1/ 2, are tax-free.

All of which makes Roths a perfect “fiscal Frankenstein”. In return for little more than ordinary upfront taxes, Congress waived untold billions in downstream Treasury receipts. Roths are also a likely drag on the economy. Since withdrawals aren’t required, assets can sit idle indefinitely.

For holders, Roth accounts become a permanent, federally-sanctioned tax shelter. For America, they’re a bit like toxic instruments on the nation’s books. Worse, Congress has them on steroids?and President Obama wants to up the dosage.

The limit on annual Roth contributions has risen from $2,000 to $5,000. Persons over 50 can add another $1,000 to “catch up”. That’s a $6,000 per-year maximum, $12,000 for a married couple, triple the original limits.

Conversions from regular IRAs to Roths ballooned starting in 2010, when income limits were removed. Conversions, set up in the 1997 law, are routine paperwork exchanges. Holders of regular IRAs cash out, pay any taxes due, and convert the proceeds to Roths. (Other retirement accounts convert in two steps: first into a regular IRA, then into a Roth.) Originally, only those with adjusted gross incomes of less than $100,000 could convert.

But Congress, via yet another tax break passed during the Bush Administration, erased the income limit. In “The Rise of the Super-Rich,” financial journalist Teresa Tritch condemned the change: “Under previous law, Roths had been off limits to wealthy Americans, precisely because the government did not want to help people amass big estates under the guise of saving for retirement. That sound principle has now been turned on its head.”

The affluent rushed through the Roth open door. Fidelity Investments handled 22,000 conversions in January 2010, roughly quadruple the year-earlier level. The Vanguard Group had close to 30,000 Roth conversions for the month (nearly 70% of its total for all of 2009), and conversions through May were five times greater than the year earlier. A December surge capped Fidelity’s fourfold increase, lifting its 2010 conversion total to about 220,000.

Roths could also multiply overnight. A provision making Roth IRAs the default retirement plan for employees at certain companies is in the 2012 budget submitted to Congress by Obama. The president, says Howard Gleckman, is being seduced by “the Siren Song of the Roth.” Gleckman is the editor of Tax Vox, a blog published by the non-partisan Tax Policy Center in Washington. Here’s his take on unlimited Roth conversions:

“Congress adopted the tax change in part as a fiscal gimmick. That’s because, within the 10-year budget window (all that matters in Washington accounting), the conversions raise revenue. At the time the law passed, CBO [the Congressional Budget Office] figured it would generate about $6.5 billion from 2010-2015. But in the long run, turning billions of dollars from tax-deferred to tax-free savings will be a huge loser for Treasury. My colleagues at Tax Policy Center figure that, through mid-century, allowing unlimited Roth conversions will reduce federal revenues by $100 billion.” (Keep in mind: that’s the toll just for conversions).

Roths may be right for individuals, but they’re wrong for America. Tax-deferred accounts are more than generous, and build up the nation’s fiscal future. Tax-free Roths gnaw away at it.

For the good of the country, it’s time to retire Roth IRAs.

Gerald E. Scorse helped pass a bill that tightens the rules for reporting capital gains.