Financial advisers often harangue their clients to contribute to Roth I.R.A.s, or to convert regular I.R.A.s into Roths. There are plenty of good reasons for “Rothification,” which I’ll get to. But let me first add a big reason that doesn’t get enough attention.
Federal budget deficits are huge, and there is no appetite for deep cuts in spending. To keep the national debt from exploding, I’m pretty sure that tax rates will rise in the years ahead. By putting money into a Roth I.R.A., you’re paying today’s tax rates and sparing yourself the tax rates of the future, which will probably be more punishing.
As a reminder, with an ordinary I.R.A., you put in money that hasn’t been taxed yet and you pay tax when you take the money out in retirement. With a Roth I.R.A., you do the opposite: put in money that has already been taxed, so you don’t have to pay tax when you take it out.
Rothification is a good deal for a lot of people even if tax rates don’t rise. Many retirees who saved diligently discover that their incomes have pushed them into a higher tax bracket than they expected. Even if they have no financial need to pull money out of their ordinary I.R.A.s, the law requires them to take “required minimum distributions” starting at age 73 — because the government wants the tax money.
Having an unexpectedly high income in retirement isn’t the worst problem to have, of course, but the unplanned-for tax bite can be frustrating anyway. And if rates rise a lot, taxes could go from frustrating to a real threat to people’s retirement security. A Roth I.R.A. is insurance against that risk: The government doesn’t touch Roth I.R.A. distributions because it has already taken its cut.
I admit that there’s no proof that tax rates will rise, but I take courage from Stein’s Law: “If something cannot go on forever, it will stop.”
The Congressional Budget Office projects in its baseline forecast that debt held by the public will reach 122 percent of gross domestic product by 2034, up from 79 percent as recently as 2019. Modern monetary theory says deficits don’t matter unless the government uses up too many resources and causes inflation. But not everybody buys that theory. If investors think debts are becoming unsustainably large, they could start to panic and their fears could become a self-fulfilling prophecy, as I wrote last year.
Sometime before panic sets in — or maybe only after — Congress and the White House will have to come up with a plan to shrink deficits. I don’t see lots of room for cuts on the spending side. Voters (understandably) won’t tolerate deep cuts in the big entitlement programs, including Social Security, Medicare and Medicaid. Interest payments on government debt are sacrosanct. And military spending is hard to cut in today’s dangerous world. That leaves the 15 percent of the budget that goes to nondefense discretionary spending — but how deeply do you really want to cut funding of highways, veterans’ hospitals, scientific research and the National Weather Service?
The only option left is raising tax rates, which are actually pretty low right now by historical standards. The top marginal income tax rate is 37 percent under the 2017 Tax Cuts and Jobs Act. Before that it was 39.6 percent. It was 50 percent in the early 1980s, 70 percent in the 1970s and over 90 percent in the 1950s. I’m not predicting rates will get that high again, but the fact that they have been there in living memory should sober anyone who thinks today’s rates can be relied upon in perpetuity.
What should ordinary people do about this? One obvious choice is to save more than you otherwise would have, in the knowledge that you’ll need more savings to cover higher taxes in the future. Robert Lucas won a Nobel in economic science in part for his observation that if people have rational expectations, when the government attempts to juice growth through tax cuts, they will foil it by increasing their savings rates.
Alas, most of us are not Lucasian savers. So we’re back to those Roth I.R.A.s. They, too, take some self-discipline. To contribute to a Roth or convert money into one, you have to take a big tax hit up front. That’s unappealing, but nonetheless a good idea. (For now I’m leaving aside other tax-minimizing strategies for retirement and other ways to leave more money for your children, such as putting money into permanent, cash-value life insurance policies, whose benefits to your heirs aren’t subject to income tax.)
Let me close with some words from a new book, “The Retirement Savings Time Bomb Ticks Louder,” by Ed Slott, an accountant and retirement consultant. It’s an update of a 2021 book he wrote. Slott gets the fiscal problem. “Congress needs money, they’re going to have to raise the rates, and the last thing you want is to have your money subjected to the uncertainty of what future higher rates can do to your retirement savings,” he writes.
Rothification isn’t right for everyone: People who are certain their tax rates will be lower in retirement, or who can’t afford to pay the upfront Roth tax without cracking open a conventional I.R.A., or who have already turned 73, among others. For everyone else: “Put up your hand and promise me: No more analysis!” Slott writes. “There is nothing more to analyze.”
Stuffing money into a Roth I.R.A. won’t help the government’s long-term budget issues — in fact, it makes them marginally worse by moving tax revenue from the future to the present. But we do what we must.
Elsewhere: Flaws in California’s Aid to Workers
California’s generous supplement to the federal government’s earned-income tax credit is poorly designed, a new study says. California provides the biggest supplement of any state to its lowest-income workers. But the credit — which is intended to make working more remunerative — has no effect on the employment of less-skilled single mothers, according to the paper by David Neumark and Zeyu Li of University of California, Irvine.
California’s supplement phases out rapidly as income rises, so it discourages recipients from earning more money, Neumark and Li found. Plus, California has a high state minimum wage. The result is that “workers who work more than a relatively low number of hours are unlikely to gain any extra income because of the E.I.T.C.,” the authors write.
Quote of the Day
“It is probably true that business corrupts everything it touches. It corrupts politics, sports, literature, art, labor unions and so on. But business also corrupts and undermines monolithic totalitarianism. Capitalism is at its liberating best in a non-capitalist environment.”
— Eric Hoffer, “Thoughts of Eric Hoffer, Including:,” The New York Times Magazine (April 25, 1971)
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