Erika Hubbard:
Now I did have, Jim, a follow-up question for Larry. But Jim, there was a question that we got in the live room yesterday at the very end, and I thought you were going to go back to me at the end for one last question, you always say, “It’s got to be a great one.” And usually when you say that I don’t have one, but I had a really good one yesterday, of course, and you didn’t. So, I wanted to get that question answered for the person who asked it. But also, I wanted to just be vindicated that I finally found a good question.
James Lange:
We all seek vindication.
Erika Hubbard:
Exactly.
James Lange:
At least I do.
Erika Hubbard:
Yeah. We got this question from Kirk yesterday and it was in the Roth-specific workshop. He asked, “Isn’t it possible the government could change the taxation for Roth IRAs and diminish the current advantages and value?”
James Lange:
Well certainly, and Larry and Adam were saying, “Hey, people who predict things are usually wrong, and you shouldn’t necessarily rely on that.” And yes, the government could certainly change the taxation of Roth IRAs in the future. There’s already talk about that. There are some possibilities that if the balance is over $10 million, they could also potentially say, “Well, now you have to start making required minimum distributions.” And obviously, it wouldn’t be as favorable as the existing law.
But this is what I would say. The real risk that I think that the questioner is worried about is they’re going to write a check to the government and that they’re not going to have anymore in order to get a tax-free investment, the Roth. What if, for example, the government said, “Hey, we decided we’re going to tax Roth IRAs anyway.” In which case, not only are you not better off, but you’re worse off.
And I’ll tell you why I don’t think that is a serious risk. And the reason is because, and you could say, “Oh gee, Jim, they said they’d never tax Social Security. Those rascals in Congress, they decided to tax Social Security. What if they do the same thing with the Roth?”
In the example of Social Security, it was never part of the Internal Revenue Code that we will never tax Social Security. The legal word for it is dicta, which is legally unenforceable language spoken by a judge or a legislator or president or some type of politician that led people to that belief. It is part of the Internal Revenue Code that if you have money in a Roth, a Roth 401(k), or Roth 403(b), etc., that that money will never be subject to income tax.
So, in order for that money to be subject to income tax, they would have to, in effect, make a retroactive change, which the legal term for that is an ex post facto, after the law change, which is a violation of due process, it’s a violation of the constitution, and you would have a pretty well-funded revolution.
So, I think if we’re going to factor in potential tax changes into the question of whether you do a Roth IRA conversion, instead of worrying about it, again, this very, very small chance, I would be thinking more what Larry was talking about of looking all the problems that we have financially, look at the Tax Cuts and Jobs Act of 2017 that says, “Hey, taxes are going to go up in 2026 unless somebody stops them.”
And we are historically in a low-income tax environment. I think the risk of having a significant increase in taxes is much higher than the risk of a retroactive tax treatment. And if that risk does occur, then you’re going to be really happy that you have got money in the tax-free environment (like Roth IRAs, 529s, life insurance, your kid’s Roth IRAs, Roth 401(k)s, and spending money for your kids). So, I think that the worry about a tax law change is actually a reason to do Roth IRA conversions, not a reason to avoid them.
Larry Swedroe:
Jim, I would just add that given that we are now well over 100% debt to GDP and almost certainly headed higher, that it’s a virtual certainty, though not certain, that tax rates are going up because rising debt to GDP he is unsustainable. So, I think that is highly likely and investors should be planning on that as the more likely outcome as opposed to either falling or stable tax rates.
James Lange:
So, Larry, even though we said don’t listen to anybody that makes predictions, I’m going to ask you one anyway.
Larry Swedroe:
Yeah.
James Lange:
So, you’re talking about a likely increase. Based on evidence, we have heard, “Oh, what if …” Well, he’s a little bit old now. I actually met him. He gave me a testimonial: “Great writing!” on an article I did for Forbes. But anyway, what if a guy like Steve Forbes wins the presidency? And he says, “Hey, the income tax is really an outmoded idea. We’re going to have a value-added tax or a sales tax.” Do you think that if that happens, that will be in addition to the income tax, or do you think that it will be a potential replacement of the income tax and all these trillions of dollars that are in the IRA, the government is just going to say, “Oh, we’re going to forget about taxes on all that?”
Larry Swedroe:
Well, first I would say this. As a trained economist, I would say we should get rid of the income tax and have only a value-added tax. And then you can make it not regressive by having a floor. If your income is less than X, you get your VAT rebated it to you. So, the first 40,000 of VAT taxes, you don’t have to pay them and that would make it a progressive tax. The wealthy then would get taxed whenever they spend it.
Larry Swedroe:
But that’s not going to happen. I just find it unlikely. So, I think what we would see is, because of the fiscal problems we are facing, Social Security and Medicare are not fully funded. They’re dramatically underfunded. There’s about a 23% or so shortfall. Within 13 years, we’ll only be able to pay out about high 70s as a percentage. I don’t think we’ll default on that. So, I think they’re much more likely to increase taxes. And I think the likely outcome is both higher income tax rates and a pretty good chance they’ll have to move to a VAT to get a broader tax base. There’s only so much you can tax on income before you actually start getting negative effects and hurting the economy as well. So, I think that’s more likely. But again, I would say never treat the unlikely as impossible.
James Lange:
And by the way, just to clarify, when Larry says VAT, that’s an abbreviation for Value Added Tax, which most of us think of as a sales tax, which now usually occurs at the state or local level, not the federal level.
Larry Swedroe:
Yeah. And in Europe typically it is in the 20s.
Erika Hubbard:
Now I did have, Jim, a follow-up question for Larry. But Jim, there was a question that we got in the live room yesterday at the very end, and I thought you were going to go back to me at the end for one last question, you always say, “It’s got to be a great one.” And usually when you say that I don’t have one, but I had a really good one yesterday, of course, and you didn’t. So, I wanted to get that question answered for the person who asked it. But also, I wanted to just be vindicated that I finally found a good question.
James Lange:
We all seek vindication.
Erika Hubbard:
Exactly.
James Lange:
At least I do.
Erika Hubbard:
Yeah. We got this question from Kirk yesterday and it was in the Roth-specific workshop. He asked, “Isn’t it possible the government could change the taxation for Roth IRAs and diminish the current advantages and value?”
James Lange:
Well certainly, and Larry and Adam were saying, “Hey, people who predict things are usually wrong, and you shouldn’t necessarily rely on that.” And yes, the government could certainly change the taxation of Roth IRAs in the future. There’s already talk about that. There are some possibilities that if the balance is over $10 million, they could also potentially say, “Well, now you have to start making required minimum distributions.” And obviously it wouldn’t be as favorable as the existing law.
But this is what I would say. The real risk that I think that the questioner is worried about is they’re going to write a check to the government and that they’re not going to have anymore in order to get a tax-free investment, the Roth. What if, for example, the government said, “Hey, we decided we’re going to tax Roth IRAs anyway.” In which case, not only are you not better off, but you’re worse off.
And I’ll tell you why I don’t think that is a serious risk. And the reason is because, and you could say, “Oh gee, Jim, they said they’d never tax Social Security. Those rascals in Congress, they decided to tax Social Security. What if they do the same thing with the Roth?”
In the example of Social Security, it was never part of the Internal Revenue Code that we will never tax Social Security. The legal word for it is dicta, which is legally unenforceable language spoken by a judge or a legislator or president or some type of politician that led people to that belief. It is part of the Internal Revenue Code that if you have money in a Roth, a Roth 401(k), or Roth 403(b), etc., that money will never be subject to income tax.
So, in order for that money to be subject to income tax, they would have to, in effect, make a retroactive change, which the legal term for that is an ex post facto, after the law change, which is a violation of due process, it’s a violation of the constitution, and you would have a pretty well-funded revolution.
So, I think if we’re going to factor in potential tax changes into the question of whether you do a Roth IRA conversion, instead of worrying about it, again, this very, very small chance, I would be thinking more what Larry was talking about of looking all the problems that we have financially, look at the Tax Cuts and Jobs Act of 2017 that says, “Hey, taxes are going to go up in 2026 unless somebody stops them.”
And we are historically in a low-income tax environment. I think the risk of having a significant increase in taxes is much higher than the risk of a retroactive tax treatment. And if that risk does occur, then you’re going to be really happy that you have got money in the tax-free environment (like Roth IRAs, 529s, life insurance, your kid’s Roth IRAs, Roth 401(k)s, and spending money for your kids). So, I think that the worry about a tax law change is actually a reason to do Roth IRA conversions, not a reason to avoid them.
Larry Swedroe:
Jim, I would just add that given that we are now well over 100% debt to GDP and almost certainly headed higher, that it’s a virtual certainty, though not certain, that tax rates are going up because rising debt to GDP he is unsustainable. So, I think that is highly likely and investors should be planning on that as the more likely outcome as opposed to either falling or stable tax rates.
James Lange:
So, Larry, even though we said don’t listen to anybody that makes predictions, I’m going to ask you one anyway.
Larry Swedroe:
Yeah.
James Lange:
So, you’re talking about a likely increase. Based on evidence, we have heard, “Oh, what if …” Well, he’s a little bit old now. I actually met him. He gave me a testimonial: “Great writing!” on an article I did for Forbes. But anyway, what if a guy like Steve Forbes wins the presidency? And he says, “Hey, the income tax is really an outmoded idea. We’re going to have a value-added tax or a sales tax.” Do you think that if that happens, that will be in addition to the income tax, or do you think that it will be a potential replacement of the income tax and all these trillions of dollars that are in the IRA, the government is just going to say, “Oh, we’re going to forget about taxes on all that?”
Larry Swedroe:
Well, first I would say this. As a trained economist, I would say we should get rid of the income tax and have only a value-added tax. And then you can make it not regressive by having a floor. If your income is less than X, you get your VAT rebated it to you. So, the first 40,000 of VAT taxes, you don’t have to pay them and that would make it a progressive tax. The wealthy then would get taxed whenever they spend it.
Larry Swedroe:
But that’s not going to happen. I just find it unlikely. So, I think what we would see is, because of the fiscal problems we are facing, Social Security and Medicare are not fully funded. They’re dramatically underfunded. There’s about a 23% or so shortfall. Within 13 years, we’ll only be able to pay out about high 70s as a percentage. I don’t think we’ll default on that. So, I think they’re much more likely to increase taxes. And I think the likely outcome is both higher income tax rates and a pretty good chance they’ll have to move to a VAT to get a broader tax base. There’s only so much you can tax on income before you actually start getting negative effects and hurting the economy as well. So, I think that’s more likely. But again, I would say never treat the unlikely as impossible.
James Lange:
And by the way, just to clarify, when Larry says VAT, that’s an abbreviation for Value Added Tax, which most of us think of as a sales tax, which now usually occurs at the state or local level, not the federal level.
Larry Swedroe:
Yeah. And in Europe typically it is in the 20s.