Jeff Benjamin

Investment Insights: The Blogblog

Jeff Benjamin breaks down the game for advisers and clients.

What Build America backpedal says about safety of Roth IRAs

Washington looks to wriggle out of promise made just two years ago; can lawmakers keep their hands off?

Nov 15, 2012 @ 2:01 pm

By Jeff Benjamin

Of all the fiscal cliff-related issues currently being kicked around, the proposed reduction in the federal subsidy to the Build America Bonds program might be the most telling of how Washington works and how politicians think. And it should be worrisome to investors who have put money into retirement savings vehicles that come with tax-free guarantees.

From a pure dollar amount, this piece of the larger sequestration package is relatively small. By cutting the federal government's support of the BAB program by 7.6%, federal funding for the program would be cut by about $250 million annually.

Of course, that $250 million annual bill would then have to be absorbed by the state and local municipalities, but that's a problem for another day.

Keep in mind that the BABs program, introduced in April 2009 as part of the American Recovery and Reinvestment Act, was designed to help municipalities issue debt for what was described as crucial infrastructure projects.

The program was unique in the muni bond space on several levels. To draw investors beyond traditional muni market players, the BABs program stripped away the tax-exempt income component. To offset that loss, so-called 'Direct Payment BABs' paid out a higher rate of interest, with the federal government providing a 35% subsidy to issuers to help pay the extra interest. Since the BABs were not offering tax-free income, the federal government's subsidy was considered to be revenue-neutral.

The 21-month issuing period ended on schedule in December 2010 after $181 billion worth of BABs were sold. The program was generally viewed to be a success, and there was even support for bringing it back.

Then came the 394-page report from the White House two months ago that included a proposal to cut the federal government's BABs subsidy from 35% to 32.3%.

In the grand scheme of the swelling fiscal cliff debate such a small cut might seem like an easy one to make. But the bigger point is that the proposed cut to the BABs subsidy comes less than two years after the same people introduced and committed to the subsidy.

If Washington can't even keep a promise for two years, how is anyone expected to feel comfortable investing through something like a Roth IRA, where investors are supposed to trust that the government will allow tax-free withdraws decades from now? And what happens if states run into another severe financial bind down the road? Lawmakers and governors could be sorely tempted to dip into the massive pool of 529 assets to help bail them out.

Farfetched? Maybe. But betting on the promises of politicians seems, at best, like a risk-on proposition, and at worst, a real throw of the dice.


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