Risky Roths

The Roth IRA is a riskier investment vehicle than commonly perceived. Here are a few reasons:

  • If Congress shifts any of the current income tax burden to some other tax, that could destroy Roth IRA’s benefits. A partial shift to a different kind of tax could reduce future income taxes, penalizing Roth IRA holders who contribute post-current-tax-rate income. Such a shift is not inconceivable. For example, shifting current income tax burdens to gasoline taxes (to reduce the demand for gas, theoretically increasing independence from Middle East oil or reducing CO2 emissions) has been discussed and could easily become a reality some day. (I am not advocating this; just pointing it out.)
  • Some predict that income taxes will rise in the future because Social Security and Medicare costs are going up, up, and away. Payroll taxes, not income taxes, fund these programs. It is possible that Congress could fund future shortfalls through increased income taxes. It is just as possible for Congress to simply increase payroll taxes. Roth IRAs give no advantage against increased payroll taxes because payroll taxes are not paid on retirement fund distributions.
  • Taxes saved now via contributions to traditional IRAs, 401(k)s, or 403(b)s are saved at one’s current marginal rate. Assuming one draws a substantial portion of retirement funds from Roth IRAs, taxes saved in the future via a Roth are saved at a rate closer to an average rate. One’s average tax rate is always lower than one’s marginal rate.
  • One’s post-retirement income is usually a step or two lower than one’s pre-retirement income. That pushes one’s future average tax even lower than one’s current marginal rate.

I could go on.

What it boils down to is with the Roth IRA, you are betting heavily on specific political outcomes (total unknowns!), and you are trading a well-defined current benefit (immediate deductibility) for an unknown future benefit. That sure seems risky, especially if your retirement date is 40 years away. I am aware of the side benefits of Roth IRAs (no mandatory distribution, can withdraw contributions at any time, etc.), but risk has a cost. Given the potential risk it sure seems like the Roth is an expensive way to get these benefits.

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