Could ROTH IRAs Have An Impact On Future Taxable Income? 

 

 

Written by Edward Brown Posted On Friday, 28 April 2023 00:00

Back in the early 1980s, when I was preparing tax returns, I made a prediction that everyone I shared with thought I was out of my mind; I predicted that the government was going to tax Social Security in the future. The objection from my naysayers was that the income was already taxed, so it would not be fair to tax it again.

My reasoning was that the government is always looking for ways to raise revenue, and it tries to do it in very sly ways. Unfortunately, I was right. First, Congress decided to have as much as half of a recipient’s Social Security be subjected to taxation; then, it was decided that up to 85% of Social Security could be subjected to tax, depending on the taxpayer’s adjusted gross income. This is not the first time Congress has done this “end run” on taxing certain income. In the “old days”, prior to the 1980s, the Alternative Minimum Tax was designed to only tax those wealthy taxpayers who could afford tax shelters and other tax avoidance schemes. However, years later, many people were subjected to this, somewhat hidden, tax as they had no idea they were being thrust into it. Certain expenses such as State Income tax deductions were added back into income and taxpayers found themselves paying more when they filed their income tax return than they expected. Worse, it was difficult to avoid this tax that was supposed to be imposed on “the wealthy” but was now subjecting middle class taxpayers.

Next, Congress decided that Municipal Bonds could potentially cause a taxpayer to pay higher taxes [on their Social Security] than they normally would by owning Municipal Bonds, depending on adjusted gross income. So, although the owner of Municipal Bonds does not pay tax on the interest earned on those bonds, the taxpayer may end up paying more taxes on other income because of the Municipal Bond income.

My predictions for the future are: first, ALL Social Security income received will be taxed. Next, since the system cannot accommodate all the Baby Boomers who are either currently receiving Social Security or are about to, the current threshold of income that is subjected to FICA from current workers will increase. Next, the retirement age at which someone can receive Social Security will increase, as they have recently proposed in France. Then, there will be a means test. If one does not “need” Social Security [by having too high a net worth or other income as determined by Congress], the potential recipient will not receive it. 

Next up on my list of predictions has to do with ROTH IRAs. For some time, many taxpayers have had the option of having a ROTH IRA instead of a traditional IRA. The plan was to pay taxes now and get it over with. The ROTH IRA would be allowed to grow without taxation as well as when the recipient withdrew money from the ROTH IRA [no penalties if the owner is over 59 ½]; however, ROTH IRAs have grown tremendously in recent years, as many taxpayers believed tax rates would increase and the thought was to pay the taxes when tax rates were less. With ROTH IRAs becoming a large part of “tax-free” growth, it is my belief that Congress will not just outright start taxing them, as this would fly in the face of what was originally proposed. The way that Congress will effectively get their tax revenue is to do what they did with Municipal Bonds as explained earlier; ROTH IRA income [possibly even the value of the assets in the ROTH IRA] may influence the taxability of other income. This would be a sly way of not directly taxing ROTH IRAs but be structured in such a way for the government to collect more taxes. This same strategy may also be applied to other deferred income that is not currently being taxed such as single premium life insurance, whole and universal life insurance and some annuities. 

I am not against ROTH IRAs, but my predictions have led me to believe that it is best to save taxes now [traditional IRAs, 401(k)s, etc.] wherein the taxpayer saves money immediately, knowing there is a 100% chance of no current tax. In addition, the taxes that are not currently paid can be invested and increase the taxpayer’s net worth. As the saying goes, A Bird in the Hand…