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 Cuts and Jobs Act in 2017, 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.
- 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, like 401K)s, would be a much richer source of tax revenue.
- Even if the law were changed, current accounts would probably be exempted.
5 Reasons Roth IRAs Won't Be Taxed (Probably)
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.
In addition, some wealthy taxpayers have found a way around the income limits on contributing to Roth IRAs. Using a tactic called a backdoor IRA, they have accumulated accounts worth millions and, in at least one reported case, billions—a possibility the Roth IRA's creators probably never envisioned.
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 pretax 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. Because you get that upfront tax break, you pay taxes when you withdraw funds from a traditional IRA.
The percentage of U.S. households that owned a Roth IRA as of 2020.
2. Roth IRAs Help Build the Nation
We like to believe that the primary purpose for 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.
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 that 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 season 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 IRA Contributions 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 year 2022, for example, 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
Compare that to 401(k) plans. They've been around since 1978, and the 2022 contribution limits are $20,500, with a $6,500 additional catch-up contribution if you're age 50 or older. On top of that, many employers add to the account by matching some or all of their employees' contributions.
If the government were to look for tax revenues, 401(k) plans would offer a much richer source.
5. Even if Roth IRAs Are Taxed, Existing Money in Existing Accounts Will Likely Be Exempted
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.
When Can You Withdraw Money From a Roth IRA?
Your contributions to Roth IRA can be withdrawn at any time without taxes or penalties (because they have already been taxed). Withdrawals of your account's earnings, however, will be subject to taxes and possible penalties unless you have had a Roth IRA account for at least five years and are at least age 59½ at the time. There are certain exceptions to the age 59½ requirement, including disability, buying a first home, and paying qualified higher education expenses. These rules are all explained in IRS Publication 590-B: Distributions From Individual Retirement Arrangements (IRAs).
What Are the Income Limits on Roth IRAs?
The income limits for contributing to a Roth IRA can change from year to year. For 2022, limits are:
- $144,000 for single filers and heads of household (incomes between $129,000 and $144,000 are eligible for a partial contribution).
- $214,000 for married taxpayers filing jointly (incomes between $204,000 and $214,000 are eligible for a partial contribution).
- For married taxpayers filing separately, the limits vary depending on whether or not they lived with their spouse at any time during the year.
This means you can contribute the maximum allowable $6,000 (or $7,000) to a Roth IRA in 2022 if your income falls below the phase-out range. If your income falls within the phase-out range, you are limited to a smaller contribution.
What Is a Backdoor Roth IRA?
A backdoor Roth IRA refers to a strategy people with incomes above the Roth IRA limits can use to fund a Roth IRA. First they contribute to a traditional IRA (which has no income limits on contributions), then they convert that money into a Roth IRA. Although this practice has been widely criticized, it remains legal as of early 2022.
The Bottom Line
Based on what we know today, you can continue funding your Roth IRA and do it with confidence. Your future self will thank you.