At Keen Wealth Advisors, we believe that long-term financial success requires a focus on two distinct areas: First, crafting a financial plan specifically tailored to your needs, abilities, and hopes for the future; and second, choosing the right investments to fund the plan.
If you think about your financial planning as a car heading towards that dream financial destination, the investments you make are the car’s engine. And over the past 20 years or so, when we pop the hood on people’s investment plans, a common engine part we see is the Roth IRA.
But with a new president and Congress in Washington, the Roth IRA has been under a lot of scrutiny. Our clients are wondering: Are changes coming to the Roth IRA? What might those changes look like? What will the effects be on my long-term planning?
Is the Roth IRA Too Good To Be True?
We use a lot of different financial tools to build the best plans for our clients, and there’s an obvious reason why the Roth IRA is so popular: it provides tax-free investment growth.
Traditional IRAs and 401(k) accounts are powerful in that they allow pre-tax money to be invested for the future, although the funds are taxed upon withdrawal. In a Roth IRA, taxes only must be paid on the contributions to the accounts. The account balance itself grows tax-free, and so upon withdrawal, no taxes are due. This is generally a great deal for investors but for politicians who are concerned about excessive tax sheltering, the Roth IRA might just be too good to be true, and maybe, shouldn’t be anymore.
Of course, incorporating the Roth IRA into your financial plan is not such a simple decision. It takes very careful analysis to determine whether it’s better to save money on a pretax basis, tax deferred, or to save money after taxes, tax free. Assumptions have to be made about future tax brackets and whether or not the government could possibly change the rules of the game on Roth IRAs.
The Politics of Changing the Roth IRA
Assumptions are tricky to make because there are many ideas about the Roth IRA and other investment tools floating around Washington right now.
Think for a second about how Congress evaluates tax policy. When tax laws change, it’s never about now, it’s about the next ten years. It’s about how tweaks in the tax law will affect federal tax revenue projections over the next 10 years.
So what would happen if President Trump and Congress decided to start taxing the money you withdraw from a Roth IRA? From a tax revenue standpoint, not very much. Investors and financial advisors would adjust their plans accordingly, and anyone who already has a Roth IRA, or sets up a new one anyway because it’s their best option, wouldn’t withdraw any money.
Is it realistic to think Congress is going to spend all that time and effort to change the Roth IRA and create, virtually, zero additional tax revenue for the federal government? Probably not.
And don’t forget another big reason Congress decides whether or not to do things: keeping voters happy. A lot of senior citizens and baby boomers paid taxes up front to put money in a Roth IRA — some of them might have built their whole financial “car” around it. And if Congress decides to rip the engine out just as those people are about to turn the key and start driving, well, we’d have some unhappy voters. Changing the Roth IRA would be political suicide.
Tweaking the Gears
That doesn’t mean Congress will leave the Roth IRA alone entirely. Some less drastic changes do seem possible, such as adding a required minimum distribution, and changing the Roth’s stretch provision for beneficiary withdrawal to a five-year rule. Congress also might cap new Roth IRA contributions at $3.4 million, and eliminate so-called “backdoor” Roth contributions, which allow taxpayers with large incomes to make a nondeductible contribution into their traditional IRAs and then convert that nondeductible deposit into a Roth later.
For now, it’s best to be patient, ignore the conjecture, and wait for Congress to propose concrete plans before deciding if the Roth IRA is a part of your financial engine that needs to be swapped out.
As always, we’re keeping a close eye on any potential changes to laws that might affect our clients and we’ll proactively reach out to you if the situation warrants.
Bill Keen is a Chartered Retirement Planning Consultant® and independent financial advisor with more than 24 years of industry experience. As the founder and CEO of Keen Wealth Advisors, a registered investment advisory firm, he specializes in providing personalized retirement planning designed to help people thrive before and during their retirement years. With a passion for educating others, Bill regularly blogs about retirement planning, hosts the podcast Keen on Retirement, and has contributed to U.S. News and World Report, Reuters, Wall Street Journal’s Market Watch, Yahoo Finance, and other publications. Based in Overland Park, Kansas, Bill and his team work with clients throughout the greater Kansas City area and across the nation. To learn more, connect with him on LinkedIn or visit www.keenwealthadvisors.com.