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What Obama's attempt to tax 529 plans says about the safety of Roth IRA assets

Changes could spark revolt, but 'when Congress needs dollars, they're going to get them,' one adviser says

Jan 28, 2015 @ 3:58 pm

By Jeff Benjamin

+ Zoom

President Barack Obama's brief attempt to tax 529 college savings plans has inadvertently reminded some financial advisers that government promises can often be temporary, and planning should be approached accordingly.

While Mr. Obama dropped his proposal to tax college savings accounts just 11 days after it was presented in his State of the Union address, the fact that it was presented at all is why financial advisers often approach Roth retirement savings accounts with caution.

“We know that when Congress needs dollars, they're going to get them,” said Phillip Cook, president and owner of Mogul Wealth Management Inc.

“It is a concern of mine that the tax rules are unlikely to be the same 20 or 30 years from now, and certain tax-law changes could easily wipe out the benefits of investing in a Roth today,” he added. “My clients have never heard me promote Roths, but I get asked questions about them quite often.”

Introduced in the late 1990s, the Roth individual retirement account essentially flipped the traditional IRA model on its head by not giving a tax break on the initial investment, but allowing for tax-free withdrawals during retirement.

Financial advisers continue to debate the best IRA version for individual clients, which will depend on age and income, as well some guestimates related to future tax brackets. But as the assets in Roth accounts have surpassed $500 billion, up from $57 billion in 1998, one can't help but assume Congress is licking its chops.

Those Roth assets, based on the Investment Company Institute's most recent 2013 data, still pale compared with the more than $6 trillion in traditional IRA assets. But traditional IRA assets are already slated to be taxed as income when withdrawn.

“My clients are asking those same kinds of questions right now,” said Leon LaBrecque, chief investment officer at the wealth management firm LJPR.

“I remind them that the government can't change the tax law retroactively, but they can change the tax law going forward,” he added. “Generally, when Congress wants to get money out of something, they do it stealthily.”

Mr. LaBrecque fully recognizes how such conversations can make one sound paranoid, but he also recognizes that Congress has already placed limits on things like mortgage interest and charitable giving deductions, which once had no limits.

“I think they will find a backdoor way of taxing those Roth assets and the most likely way is a national sales tax that just taxes everything,” he added. “I tell my clients, 'They're not going to tax the Roth, they're just going to tax everything.'”

Retirement-planning specialist and InvestmentNews contributing editor Mary Beth Franklin acknowledged the concerns over future tax laws, but added that uncertainty is an unfortunate reality when it comes to retirement planning.

“I've listened to concerns about the government taking away tax-free Roth distributions ever since Roth IRAs were created,” she said. “Likewise, there are always concerns about future changes to Social Security benefits, particularly worries that the benefits would become means tested.”

Regarding any attempts to abruptly start taxing Roth withdrawals, Ms. Franklin said there would likely be a major revolt.

“It would be like a scene from Young Frankenstein as angry mobs take to the streets,” she said.

The tax-revolt scenario is also what comes to mind for Gilbert Armour, a financial adviser with Sagepoint Financial.

“While it's certainly a possibility that Congress would try to tax Roths as they're trying to scrape together resources to pay for something, I don't think it's going to happen,” he said. “I think there would be a revolt, especially from people who converted from a traditional IRA, but I could see Congress just getting rid of the Roth as way to raise taxes.”

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