Will Roth IRA Withdrawals Be Taxed in the Future?

Today, they offer some of the best tax advantages of any retirement account. The fear exists, however, that Roth IRA withdrawals might somehow be taxed in the future. The U.S. government’s budget deficit problems began stoking the flames back in the early 2010s. More recently, the tax reform legislation of 2018, which decimated many itemized deductions and eliminated the ability to undo traditional-to-Roth-IRA conversions, added fuel to the fire.

Under current tax law, you can withdraw Roth contributions and their accumulated earnings tax-free as long as you’re at least age 59½ and it has been at least five years since you first contributed to a Roth IRA.

Key Takeaways

You already pay tax on your Roth IRA contributions in the year you make them.
Taxing Roth IRA withdrawals would effectively kill a source of investment capital for the nation’s economy.
Other retirement plans would be a much richer source of tax revenue.
Even if the law was changed, current accounts would probably be exempted.

5 Reasons Roth IRAs Won’t Be Taxed

The rationale for speculation over taxing Roth IRA withdrawals is that the tax break looks far too generous. Other tax-sheltered retirement plans, after all, are merely tax-deferred—meaning you’ll pay taxes on them eventually. The earnings on Roth IRAs are effectively tax-exempt.

But as much as taxing Roth IRA withdrawals may seem inevitable at some point, there are at least five reasons it probably won’t happen.

1. Roth Contributions Aren’t Tax-Deductible

You pay taxes on your Roth IRA contributions. The dollars deposited into a Roth are after-tax dollars. So, you don’t get an upfront tax break, but qualified withdrawals are tax-free.

In contrast, contributions to traditional IRAs are pre-tax dollars. If you meet the income limits, you can deduct your contributions when you file your income tax return. That lowers your taxable income for the year and saves you money on taxes. Since you get that upfront tax break, you pay taxes when you withdraw funds from a traditional IRA.

2. Roth IRAs Help Build the Nation

We like to believe that the primary purpose of establishing tax-sheltered retirement plans is to help people prepare for retirement. But there are other factors that operate at a macro level.

Every nation needs a capital base upon which to build and expand its businesses and industries. That means somebody somewhere needs to be saving money that will eventually find its way into investments like stocks, bonds, and real estate.

Also, large federal deficits mean that there has to be capital willing and available to buy the government’s debt.

35.3%

The percentage of US households who owned a traditional or Roth IRA in mid 2020.

However, Americans are notorious for being non-savers except in tax-sheltered retirement plans. No matter what methods the government may use to try to raise tax revenue, retirement plans are likely to retain their favored tax status.

Favorable tax treatment is a big reason why anyone invests in a retirement plan. If the tax benefits go away, so do the plans, and a big chunk of the nation’s capital base goes with it. That would lead to even bigger fiscal problems than we have now.

This leads us neatly to the next reason why Roth IRA withdrawals are unlikely to be taxed.

3. A Tax on Withdrawals Would End Roth IRAs

If Roth IRA withdrawals were taxed, it would almost certainly kill the program. Tax-free withdrawals are the special sauce that seasons this investment dish. Take it away, and you’re basically left with just another tax-deferred savings account, and we already have several of those.

The Roth IRA program is growing rapidly, making ever-larger contributions to the nation’s economy. We can rest assured the government has no interest in ending the program, which is exactly what would happen if withdrawals were made taxable.

4. Roth IRAs Are Comparatively Small

Although they are increasingly popular, Roth IRA plans remain a relative lightweight in the retirement-plan lineup. They’ve only been in existence since 1997. And in dollar terms, the annual contribution limits are relatively low.

For tax years 2021 and 2022, the most you can contribute yearly to a Roth IRA is one of the following:

$6,000, if you’re under age 50
$7,000, if you’re age 50 or older

The 2019 Roth IRA contribution limits represent the first increase in six years, but has remained the same for tax years 2020, 2021, and 2022.

Compare that to 401(k) plans. They’ve been around since 1978, and the 2021 contribution limits are $19,500 ($20,500 for 2022), with a $6,500 additional catch-up contribution if you’re age 50 or older, plus employer matches.

If your employer adds a match, it doesn’t count toward your contribution limit. But the IRS does cap the total combined contribution limit by you and your employer for 401(k)s. For 2021, that’s:

$58,000 ($61,000 for 2022), if you’re under age 50
$64,500 ($67,500 for 2022), if you’re age 50 or older
100% of your salary (if it’s less than those dollar limits)

If the government were to look for tax revenues, 401(k) plans would offer a much richer source.

5. If Roth IRAs Are Taxed, Participation Will Be Grandfathered

How can we know this for sure? Just read the tax code. It’s filled with special provisions. Look for the prefixes “pre-” or “post-” followed by a date. You can find them all over the IRS regulations.

Whenever these words appear, it usually means that a special allowance has been made for anyone who participated in a program before the regulations were changed. This will almost certainly be the case if Roth IRA withdrawals are made taxable at some point in the future.

Based on what we know today, you can continue funding your Roth IRA and do it with confidence. Your future self will thank you.

This article was originally published by Investopedia.com. Read the original article here.