Bryan Caplan  

The Credibility of the Roth IRA

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What is your probability that assets in Roth IRAs remain untaxed by the federal government through 2050?  Why?

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COMMENTS (34 to date)
John Roche writes:


bjk writes:

Withdrawals will get taxed above a certain income. In that sense they'll be like a 401k. But allowing investors to *compound* tax free is huge, and I don't think that will be touched.

Doc Merlin writes:

Near 100%.

I'm believe that a lot of legislators have Roth IRAs they wish to remain untaxed.

Prakhar Goel writes:

I agree with John Roche. They are simply too nice as another source of revenue. Ubiquitous welfare programs will mean that there are no penalties for not saving. Thus screwing over savers is a cost-free proposition.


The revenue from tax-free compounding may be huge and that is why the government will go after it.

@Doc Merlin

I am sure legislators can find (or create) more obscure tax-loopholes for themselves. The power they get immediately from expanding the tax-code is too much.

Tom writes:

Zero percent. They will not be taxed directly, though, but through 'means testing'.

8 writes:


They will first forbid adding new funds, in which case they may grandfather them.

Lord writes:

I doubt they will be taxed directly but very likely when spent.

ryan yin writes:

70-80% if you mean directly (with most of that 30% coming from the aforementioned means-testing).

A whole lot lower (10-20%?) if you count a transition to or addition of a VAT (since a transition is equivalent to adding an ongoing labor income tax and a one time tax on savings). Though that only matters if you're comparing Roth to spending, not to a traditional IRA.

MnM writes:

You ask it as an empirical question, but there is no possible way to provide an empirical answer.

I think it likely that, before 2050, the rules will be changed such that the capital gains are taxed at withdrawal.

I don't know how to provide an answer more specific than "likely".

Charlie writes:

I think it's small, less than 5% (assuming you are only talking about changes to current laws, as someone mentioned Roths are always taxed when you withdraw).

My reasoning is that even if the government needed to do some sort of capital tax or savers tax going after the Roth is very low on the list of stuff they could do. For one, the Roth is already means tested, if you make over like 100k you can't put money in.

Things they would do first include:

1. Raise the tax on capital gains
2. Raise the retirement age on Social Security.
3. Change the index on S.S.
4. Means test S.S.
5. Means test medicare
6. Tax health savings accounts

Gov't, in general, seems pretty reluctant to go after promises they've made. It's one of the reasons the S.S. age has stayed so low over the years. It seems there's lots of lower hanging fruit between now and it.

MnM writes:


Roths are not taxed at withdrawal-you contribute with after-tax money precisely so you can avoid paying taxes at withdrawal. It's like a hedge against a future tax hike...

Ben Lavender writes:

Thank you for asking this. 2045 is my approximate retirement timeframe, and the cold math of the US' fiscal situation forces me to fully expect social security to be gone or reduced in benefits, and my IRA appropriated, either in full, in part, or indirectly. I *really* wish this issue had more attention. For someone who cannot afford, say, foreign real estate, but instead saves 10-15k a year, it's exceedingly difficult to find a 'safe bet' to squirrel away enough to retire on a little bit at a time. Diversification from political risk requires a lot more capital than one can make just working.

The legislative uncertainty has forced me to the decision that I will buy a house when I determine the bottom is close enough, even though I am youngish, telecommuting, and unattached. I despise the idea of a mortgage at this point in my life. Unfortunately, it seems the most politically unpalatable thing to take, and vaguely safer from currency devaluations as well.

The current bout political changes, wars, and structural upheavals like health care are making it really hard to climb the ladder incrementally. The time horizon is long enough that who knows what will happen; it's really hard for me to forgo a vacation to save with that kind of uncertainty. It's bad news for the idea of a middle class.

I'd *love* to see more economists blogging on this. I don't think the uncertainty in the US for a long time horizon is adequately covered these days.

Geoffrey writes:

I tell everybody I know. Don't invest in a Roth IRA (I follow my own advice)..

When people start pulling several 100's of thousands of dollars, It is going to be too tempting a target..

Lo Statuz writes:

67%. I'm guessing the probability Roth IRAs will escape taxation in any one year is 99%, so over 40 years it's about 67%. Geezers are politically powerful, but in any one year I figure a 1% chance of a big enough crisis for politicians to exploit. As ryan yin points out, it's much easier to tax the consumption of the distributions, for example with a VAT.

floccina writes:

I am close to 100% sure that except for those IRA held by the top 5% wealthiest people they will remain untaxed because old people vote. In taxing you always want to target a small minority of voters.

Steve writes:


You're mistaken; no one previously said that a Roth IRA is taxed when you withdraw. In fact, it is not. Traditional IRA is taxed at withdrawal, but Roth IRA money was taxed before it went in, so it is tax-free on its way out.

Government does crazy things to keep its specific promises. It may not keep general promises, but when has our government ever changed rules on us ex post facto (even the AIG bonus bonanza seemed to die down once the media shifted its reporting of public outrage from AIG to the next flavor of the day).

Justin writes:

I'd guess that there is a very low chance of Roths escaping taxation, especially via means testing of entitlements and/or a VAT. I'd put it at 5% that we don't see either one of those.

A 15% VAT and, say a 1% straight line decrease in Social Security benefits for every $20,000 increase of wealth would nuke a significant portion of the value of most Roth IRAs.

That said, I don't think there will be an explicit tax on Roth balances, given these ways to tax Roths indirectly.

hanmeng writes:

I have no idea as to the probability, but I find the question funny in an awful way: I recall several years ago when I was considering converting my regular IRA's into Roths, I read a warning that the government was not to be trusted to keep its hands off.

By the way, I did convert them all.

Mark Bahner writes:

"For someone who cannot afford, say, foreign real estate, but instead saves 10-15k a year, it's exceedingly difficult to find a 'safe bet' to squirrel away enough to retire on a little bit at a time."

If you can save 10-15k per year for the next 35 years, I wouldn't worry much about retirement, if you're putting that money into a 401k plan (or equivalent).

One thing I would suggest, though...invest a significant percentage (say, 50% or more) in very broadly based emerging market funds (e.g. China and India).

"I'd *love* to see more economists blogging on this. I don't think the uncertainty in the US for a long time horizon is adequately covered these days."

The uncertainty on the upside is essentially not covered at all. See, e.g.:

How many economists do you know who are predicting a world per-capita GDP growth rate of over 10% per year in the 2030s? :-)

Mark Bahner writes:

"Held pending approval."

I must talk in spam! ;-)

Joe Kristan writes:

First, the commenter who points out that Roth withdrawals (done right) are tax-free forever under current law is correct.

I think the possibility of taxing Roth withdrawals is under 1/3, because it would be such an egregious breach of faith. I know, they're politicians, so they can't be trusted. I do worry about it, but my 401(k) is still going into a Roth 401(k), after tax.

It's much more likely that future Roth contributions will be ended, but even that's not a slam dunk. Budgeteers like Roths because that they don't reduce revenues now; when you substitute Roth deferrals for deductible 401(k) deferrals, it helps their deficit number now, even though it hurts them later.

It's much more likely they'll get it indirectly via a VAT or something similar.

Yancey Ward writes:

Zero percent. The principle portion probably won't be taxed (again) by income taxes, but the gains eventually will be treated just like a normal IRA or 401K.

The principle portion will likely be taxed by a national VAT.

The key is that most people will not have a Roth IRAs, most people will have traditional ones, 401Ks, and pensions, all of which face income taxes. There will be no large constituency to protect the promise.

Matt C writes:

If you mean, what is the probability that in 2050 your Roth would have the same effective benefits than it does today, then very low. Less than 5%.

I agree with others that a VAT is an easy and likely way for Roth holders to get screwed.

I don't expect outright repudiation of the Roth promise (though it's not unthinkable), but like others have said, there are plenty of indirect ways to get the same effect. It might still be worth contributing, even with attenuated benefits. But I've quit adding to mine.

Ned Baker writes:

Of what relevance is a VAT to the original post? This affects all retirement proceeds equally, no matter their source.

Milton Recht writes:

I am not sure it is a meaningful question. At some point, the government will reduce the deficit and the debt levels. Part will be reducing spending and part will be from increasing revenues.

To get the revenue, the US can increase tax rates or broaden the definition of taxable income. For example, both are used to compute the tax on social security payments. The payments are taxable and the amount (tax rate) depends on looking at total income including tax-free municipal bond interest income.

The government's goal will be to produce an amount of revenue. All the tax revenue will come from individuals and other taxable entities. In the end, the methodology of computing the tax will be irrelevant. Individuals will end up paying $X dollars of tax in aggregate. With a smaller income base, the average tax rates will be higher and with a wider income base, the rates will be lower, but the total targeted tax revenue will be constant. Rates and the income base will be adjusted until individuals pay the $X in tax revenues.

If in the future, Roth IRAs are tax-exempt, then either the average tax rate will be higher or the income base will be broader in some other way.

In the end, we will pay the same amount of taxes.

Justin writes:


Agreed a VAT would impact all retirement vehicles equally.

That said, it would be a way for the federal government to tax wealth created in a Roth IRA as it is consumed by retirees.

It doesn't mean that the Roth is now a bad choice vis-a-vis the regular IRA, just that it might not be the completely tax free savings vehicle it is advertised to be.

Floccina writes:

The danger of new taxes (like a VAT) is another reason that anything like home insulation that has a payback is the best type on investment. A metal roof that will last longer. Insulate that home, if you hire lawn mowers instead have landscapers put in low maintenance xeriscape. A penny saved is 2 pennies earned because you already paid taxes on it.

BTW it is the median voters that is the problem not the politicians. Will the median voter go for fat Roth IRAs, I doubt it.

8 writes:

How much money will be in Roth IRAs? I don't think it's ever going to be a significant amount of money compared to other asset sources. Why not do away with the capital gains exemption on homes, for instance?

More likely is that they would force people to take distributions. Right now, you can leave a Roth untouched until you die.

Matt C writes:

If a VAT shifts the tax burden from income taxes to the VAT, then a Roth IRA may be a loser relative to the traditional IRA. As an extreme example, suppose the income tax is entirely replaced by a VAT in 20 years. The Roth IRA that you paid income taxes on today isn't much of a deal in that case.

That's maybe not a likely scenario, but it illustrates the point. Maybe a Roth will still be a better deal than a traditional IRA for some people. But a future consumption tax has to count in favor of the traditional IRA, when compared to a future of only income taxes.

Back when I paid attention to financial planners, I never saw one raise the possibility of a VAT when they were pitching the benefits of a Roth IRA. Higher future income tax rates, they mentioned. A consumption tax, no.

Charlie writes:

Even if we went to a full VAT, it's hard to imagine that not being accompanied by an age-adjusted deduction. Seniors will be a large and powerful voting block and will not want to be double taxed. The only people likely to be worse off in such an arrangement are very high earner/savers, and Roth IRAs won't be a very significant part of their portfolio.

Jeremy, Alabama writes:

The revenue temptation will be irresistible.

They will start by demagoguing the issue, that the Roth "loophole" provides "Cadillac" pensions for high earners. It is likely to form part of a gigantic 401k asset seizure, e.g., requiring personal retirements to hold govt bonds.

This will happen in the next Democrat congress after a Republican one, say 12-15 years. They will be desperate for money.

Doc Merlin: legislators get their money by spending other people's, not by saving their own.

Jim Glass writes:

If they follow basic tax principles they will tax the appreciation of a Roth IRA's value while not taxing the after-tax contributions to it -- its tax basis -- thus making the tax treatment comparable to other investments.

This also follows the rationale used by Congress when it made Social Security benefits taxable -- first 50% taxable (the idea being that the "half" allocable to after-income tax employee contributions should be tax free, the other half attributable to employer contributions taxed) then 85% taxable (an estimate of the average portion of benefits in excess of the "basis" amount of employee contibutions).

Trevor H writes:

I'm reluctant to quantify a guess. I'm 40 years old, I can tell you that I have not opened a Roth IRA specifically because I do not trust them.

Carl Edman writes:

Same here.

I have substantial funds in 401(k)s and IRAs and--now that it is permitted--I probably would have converted at least part to a Roth IRA. Think of it as tax rate risk diversification. Also, by choosing the withdraw from a Roth IRA during periods of high income and high marginal rates, and a regular IRA during periods of low income and low marginal rates, having both in effect captures a free option value.

The reason I have not converted and likely will not? Prof. Caplan's. I do not trust the government to keep its express promise not to tax Roth IRA income on withdrawal. Three stories on the nightly evening news of the undeserving rich eating caviar while living tax free off their Roth IRAs while poor homeless vets have to live under bridges because of cruel cuts to human services and that promise will be worthless.

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