Are Roth Accounts on the Way Out? Here's What You Need to Know

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  • Short-term cash generation makes Roth accounts politically popular.
  • New legislation indicates a favorable attitude toward Roth accounts in Congress.

Will this tax-advantaged savings vehicle soon disappear?

When it comes to saving for the future, a balanced strategy isn't only diversified in terms of investments, but also taxability. This is one of the reasons why many Americans have Roth IRAs or contribute to Roth 401(k)s. However, some speculate that Roth accounts may be restricted or disallowed altogether, starting with backdoor Roth conversions. Are these fears founded in fiction or fact? Read on to find out.

Paradoxically political popularity

Briefly, let's talk about how Roth accounts work. Instead of traditional tax-advantaged plans, where contributions are tax deductible and withdrawals are fully taxable, Roth accounts allow the payment of tax on contributions with the benefit of tax-free withdrawals. However, because of the growth of an investment account over time, the tax liabilities on a traditional and Roth IRA are not equal. An investment account's gains would be taxed upon withdrawal in a traditional account, but would avoid taxation in a Roth account.

Why would the government allow such an enormous loophole? Wouldn't a rational government realize it is missing out on millions of dollars of tax revenue if it disallowed Roth contributions? Although it should be noted that governments pursue social well-being and not only their bottom lines, it is important to consider that governments are also somewhat irrational.

According to a 2019 report from the Tax Policy Center at the Urban Institute & Brookings Institution, governmental bodies focus closely on a 10-year budget window. By looking at near-term cash flows, new projects can be funded, showing progress to constituents today and enhancing re-election odds. However, a 10-year focus rewards tax dollars generated by Roth accounts today, instead of higher tax revenue from traditional accounts decades down the road. So, while rationally a government should disallow Roth accounts and cash in on greater taxes later, in a myopic government, Roth accounts remain incredibly popular.

What is (and isn't) in SECURE Act 2.0

Until recently, the Roth debate was shrouded in mystery and hypotheticals. But recently, legislation known as the Securing a Strong Retirement Act, so-called SECURE Act 2.0, passed the House of Representatives. This bill gave taxpayers a clear indication of Congress's leanings on Roth accounts, among other financial topics. Buried in the 140 pages of text, the bill indicates the future of Roth accounts in both what is included and not included in the bill.

What is included in the bill? In regard to the future of Roth accounts, two provisions stand out. First, the family of Roth accounts would increase upon the implementation of the bill, with Roth SEP and SIMPLE accounts being allowed. Second, Roth contributions to accounts would be changed. While catch-up contributions to retirement accounts have previously been allowed to be traditional or Roth, the legislation would require these contributions to be on a Roth basis. Additionally, while employer contributions to 401(k) plans have previously been limited on a traditional basis, the bill would allow Roth employer matching contributions.

However, the most telling signs of Congress's sentiment may be in what is left off the bill. In this case, the long awaited ban on backdoor Roth conversions did not materialize. SECURE Act 2.0 represents the first major piece of finance-related legislation since the tax-diversifying strategy became wildly popular. If Congress were interested in closing the conversion "loophole," this bill would have been a great opportunity to do so.

Regardless of whether this legislation is passed, the provisions it has and does not have represent a favorable attitude toward Roth.

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