Roth IRAs and the Fear of Future Legislation

Written by Trent Hamm, The Simple Dollar is a popular personal finance blog that chronicle's one man's road back from overwhelming debt to financial security. Hamm declared the contents of the blog to be in the Public Domain in 2008 and available for sharing when attributed properly. We will share a couple of posts a week.


Roth IRAs and the Fear of Future Legislation



 

When people realize how incredible the deal is for a Roth IRA, they’re often in disbelief. After all, it lets you earn tax-free income in retirement. No federal income taxes, period, on money taken out of a Roth IRA when you’re at retirement age (and at a few other life opportunities, too).

 

Before we head too far down this road, let’s touch on what a Roth IRA is. I spelled it out in my earlier Roth IRA basics article, but here are the key things you need to know:


A Roth IRA is a type of Individual Retirement Account (that’s the IRA abbreviation, of course) that allows most individuals to save for retirement on their own with or without a 401(k) plan at their workplace. Someone working at Home Depot could start a Roth IRA, as could a janitor or a computer programmer working for the government.


The best way to think of a Roth IRA is like a special savings account. Just like a savings account, you open a Roth IRA at a financial institution. Just like a savings account, you add money to it, ideally on a regular basis. Just like a savings account, it builds up money over time.

 

Why is it so good?


if you are over 59 1/2 and have had the account for more than five years, there are no income taxes whatsoever on anything you take out of a Roth IRA. When you take money out of a savings account, you owe income tax on the interest. When you eventually take money out of your 401(k), you’re going to owe money on everything you take out. With a Roth? You owe no income taxes once you’re of retirement age.

 

There are a few restrictions, of course, but they’re very minor. It works this way for the vast majority of Americans.

 

When something seems this good, the healthy response is usually to doubt that good fortune. It makes complete sense to wonder when the government will close this system down.

 

I’ve received many emails over the years from readers who doubt whether they should put money into a Roth IRA because they’re sure that the government will shut down such a good thing.

 

My response? You’re missing out by not investing. The government is extremely unlikely to touch Roth IRAs and, even if they did, they would offer a parachute for those already in the accounts.

 

Let me explain my reasoning piece by piece.

 

First of all, significant percentage of Americans have Roth IRAs. If Congress ended the program, they’d have a very large number of voters out there enraged at them. Those voters are typically middle to upper-middle class, meaning they would have resources to spend on getting new people into Congress.

 

I don’t think that there’s a Congressperson alive that wants to severely irritate 20% of the voters in their district by directly attacking their personal savings for retirement.


If the government ever had a financial need to do this, they would offer a parachute. They might close new Roth IRAs or future contributions, but I basically can’t conceive of them ever touching plans that are currently in place. The backlash against them would be tremendous. Congress simply doesn’t enact laws that will meet with a lot of resistance unless there are even more people that will love the new law. It’s not how Congress works.

 

If we are ever in a financial situation as a nation where such laws are being seriously considered, then we have far bigger problems than our Roth IRAs. There may be minorchanges to the Roth IRA system in the future, but major ones would trigger so much backlash that Congress wouldn’t consider them unless there was a crisis so deep that it became sensible to do so, in which case the tax status of a Roth IRA would be a minor issue compared to the other problems going on.

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