The Roth Rollover Boondoggle

By :: September 3rd, 2009

High-income investors are about to enjoy a massive tax windfall from Uncle Sam. In just a few months, they’ll be able to convert their Individual Retirement Accounts--where investment earnings are taxable at withdrawal-- to Roth IRAs-- where they are tax-free. As financial planners are happily telling their big-ticket clients, this will be the gift that keeps on giving.

You’d think that, facing a deficit of more than $1.5 trillion this year and more than $9 trillion over the next decade, President Obama would be thinking twice about this. But, as far as I can tell, he is not. So if you are making more than $100,000-a-year and have an IRA, get ready to roll on January 1.

Not only can you convert existing IRAs, but you’ll be able to make new contributions to a Roth, now barred for those making $100,000 or more. You’ll first have to contribute to a non-deductible IRA, then roll to a Roth, but given the tax savings involved, it is worth the paperwork. Another nice deal: Unlike a traditional IRA, you won’t need to make withdrawals at 70 ½ (or ever). Thus, rich retirees who don’t need Roth assets to pay the pool boy can keep accumulating tax-free assets until they die. Finally, if you think tax rates will rise (not a bad wager given the ballooning national debt), you can lock in today’s relatively low rates by converting.

The rollover works best for those who are sufficiently wealthy to pay the tax out of their taxable accounts, rather than having to dip into the IRA itself. Their only downside to the converted: some of the tax benefit will disappear for those hit by the Alternative Minimum Tax.

The scandal is that this give-away was adopted as a revenue raising measure. Under Congress’ bizarre budget rules, it helped “pay for” President Bush’s 2005 proposal to extend low rates on capital gains and dividends through 2010 and provide additional temporary relief from the Alternative Minimum Tax. So, Congress financed a set of unaffordable tax breaks with another unaffordable tax break. Only in Washington.

Here’s how: When you convert to a Roth, you’ll be taxed as if the transaction were an ordinary distribution, though you get to pay over two years. The Joint Tax Committee figured it would generate about $6.5 billion over the 10 year budget window (which is all Washington cares about). But the long-run story is dramatically different.

TPC’s Jeff Rohaly estimated the long-term revenue loss at an eye-popping $100 billion by mid-century. The net present value of the break, which matters since investors are paying tax upfront and will get their tax benefits over many years, will be almost $15 billion. For the government, that’s more than $2 lost for every dollar gained. Indeed, Treasury will lose more and more money each year until 2046, when many of those enjoying the windfall will have died off. Worst of all, the greatest drain on the Treasury will occur just when the aging Baby Boomers are putting the most pressure on the federal budget.

It will be fascinating to see how the rollover works in the current economy. Two thoughts come to mind. First, because stock prices are lower today than JCT thought they’d be, Treasury may end up with much less money inside the budget window than Congress expected. Second, I wonder if some of those taking advantage of the windfall will end up spending less so they can pay the rollover tax, thus slowing the economic recovery.  Oops.   

Whatever happens in the short-run, the Roth rollover is a deal with the fiscal devil. But  nobody is likely to do anything about it—at least not for a while.


  1. Anonymous  ::  12:28 am on September 4th, 2009:

    The Federal Government will have a Sales Tax or VAT (like Europe/UK) in place before any of this money is being drawn out, so don't worry…Boomers will get hit with the switchover tax now and then hit AGAIN when they want to spend it.
    Ordinary Income tax is clearly not going to be enough to
    float the federal boat….you can see this coming a mile away.

  2. Anonymous  ::  12:52 am on September 4th, 2009:

    Yes, but any way you slice it, it is a huge revenue loss as far as the income tax goes.

  3. Anonymous  ::  2:28 am on September 4th, 2009:

    VAT doesn't change the relative advantage of Roth IRAs, unless you think income tax rates will come down.

  4. Anonymous  ::  4:24 pm on September 4th, 2009:

    It depends. If a VAT structure is adopted, it is likely that traditional IRA holders will pay a penalty for taxes they would no longer have to pay at withdrawl while Roth holders would get a rebate on taxes already payed. The percentage rate for the two would have to be fairly even.
    Regardless, this is quite a windfall for wealthy investors and their heirs, although if they have too much in their accounts they will pay an estate tax (unless we shift to a system where heirs pay for estate liquidation as normal income over a certain annual dollar figure).
    I doubt that anyone will stop this – and it would have to happen fairly quickly. Does anyone on Rangel's staff read this blog – or would Baucus block any change? I think probably no on the former and yes on the latter.

  5. Anonymous  ::  8:09 am on December 29th, 2009:

    The Roth rollover is NOT NEW. I rolled over several years ago. As long as your income was less then the threshold you could do it. I paid the tax due at the time of the rollover so I won't have to do it later and my heirs won't either. Get the facts straight on this and lose the attitude.

  6. Anonymous  ::  4:06 am on January 2nd, 2010:

    Good post and great explanation. Thank you. I agree with those who predict a higher payroll tax and a VAT with various municipal sales tax hikes depending on their local budget deficits. The FIT will rise but slowly so as not to attract to much attention.

  7. Anonymous  ::  4:24 am on March 11th, 2010:

    Aside from the liberal innuendo of the author that somehow the wealthy own more tax than the oppressive 70% the top 10% pay already when half the working persons in the US pay ZERO TAX, this is a good idea. IRAs are essentially worthless. They tie up capital and prevent its use under threat of penalties. ROTH has a big upside especially for savvy investors.
    the reason this makes sense is because many 401k asset pools were destroyed in the subprime. So the actual tax burden is low compared to the potential tax free gains at a market bottom. Plus few 401K plans allow participants to play the short side of markets or hedge on margin. That is not the case with the ROTH. So the ROTH is better if you are a good investor no matter what your income.
    There has never been a situation where you tax the rich and improve the economy. Obama has been poison and his threat to tax have caused the wealthy to shut down small businesses or move them overseas. Tax cuts not tax increases are the only way to stimulate any real economic growth. Obama has increased the size of gov by 33% in one year and is fast turning the US into a socialism quagmire with lots of debt. But golden goose is leaving. A Roth is one method of keeping the wealthy in the game. But if the game is only to use them to pay taxes on a worthless bloat of gov, the the US will lose anyway.
    I think it is about time that the wealthy were not excluded from tax breaks and got fair treatment instead of all the burden. I hate the progressive tax system which is inefficient. Consumption taxes conserve, and reward those who save. The present tax system reward those who sit on their bums and don't do anything but have their hands out. Savvy US investors need to get out of mutual fund driven 401K plans.

  8. tim  ::  6:30 pm on September 14th, 2011:

    My heart bleeds for them.

  9. Gerasim  ::  3:51 am on April 26th, 2013:

    Thank you for what you have got. This is the most beneficial submit I’ve read

  10. Anastasia  ::  4:26 am on April 29th, 2013:

    Just want to say your article is as amazing. The clarity for your put up is just great and i could assume you’re an expert in this subject.

  11. audible thoughts  ::  12:15 am on July 4th, 2013:

    We absolutely love your blog and find nearly all of your post’s to be precisely what I’m looking
    for. can you offer guest writers to write content for you personally?
    I wouldn’t mind writing a post or elaborating on a number of the subjects you write regarding here. Again, awesome web log!

  12. guruarie  ::  12:32 am on May 7th, 2015:

    Thanks for your analysis, it help me to understand how all those works Paket Honeymoon jogja Jogja