Sometimes my clients tell me a scary story, as if we were sitting around a campfire instead of my conference room table. It goes like this: The United States is in trouble. The population is aging and retiring. Social security and Medicare costs to the government will skyrocket in the years to come. At the same time, there will be fewer workers paying taxes into the system. National debt will balloon from its already bloated state. The government will have only one choice—raising taxes. Like an out of control monster, these taxes will consume greater and greater portions of our income. Some of that retirement money we put into tax-deferred IRAs will be eaten by this monster, leaving us worse off.
The solution, they tell me, is obvious. Convert to a Roth IRA, which allows you to go ahead and pay taxes at today’s tax rates. Then the money can be withdrawn tax-free in retirement, outsmarting the monster!
It’s a good story, I admit. But before starting that Roth conversion, let’s think this through. Raising income tax rates is not a politically easy thing to do. It’s quite possible, maybe even likely, that the government will choose to raise revenue (or lower costs) in other ways. For instance, it might:
- Institute an entirely new tax, such as a national sales tax or value added tax (VAT)
- Remove or reduce tax loopholes or deductions, such as the home mortgage deduction
- Increase payroll tax rates
- Raise the retirement age for Social Security benefits
All of these proposals have been discussed in Washington. And any of them could raise government revenue (or reduce costs, in the case of the last one) without raising (and possibly even lowering) the marginal income tax rates that apply to your retirement funds. So yes, demographic shifts in the U.S. could lead to a larger tax burden in the future. But that does not mean you should convert to a Roth IRA. What matters is whether the marginal income tax rate you face today is likely greater than the rate you will face in retirement. Triggering a hit from taxes today, while hoping for a rate increase down the road to justify that action, is a gamble I would advise against.
Your personal circumstances and plans, of course, will be the determining factor as to whether a Roth conversion is a good idea. And that is where the conversation needs to go from here. In the meantime, don’t panic if you hear the scary story above.
At PARTNERSINWEALTH, we help you avoid such needless worry by keeping a 360-degree view of your financial life, being your sounding board on all financial matters and watching out for risks every day. To learn more about what we can do for you, please contact Jim Waters, CFP®, at 713.964.4028 or firstname.lastname@example.org.