Roth IRAs: Safety in Numbers?

Last month, I discussed why I'm not as excited about Roth IRAs as many people who write about consumer finance: I don't believe that the government is ultimately going to be able to keep it's hands off a pretty big pot of money.  Getting a tax break now in your 401(k) or traditional IRA is guaranteed; getting a tax break in the future is not.

Jennifer Kowal, a law professor at Loyola, disagreed:

Washington might be tempted to look for additional revenue in 401(k)s and IRAs, which make up 40% of the stock market's trillions in value, but it's extremely unlikely that Congress will go after Roth IRAs. This would obviously be unfair to those who made the choice to lock up their money under the promise that future earnings would be tax free. 

That something isn't fair is no guarantee that it won't happen. But Congress has bigger fish to fry than Roth IRAs. The wealthiest 1% of Americans own more than 40% of investment assets. The maximum Roth IRA contribution is $5,000 per year, and those making more than $122,000 per year are ineligible (not a particularly enticing target for even the most tax-happy politician).

Don't get me wrong; I think that Congress is going to go after all of it.  But Congress doesn't have to do anything special to get money out of traditional IRAs; it just has to raise income taxes.  (401ks and traditional IRAs are taxed at ordinary income tax rates).  Roth IRAs, on the other hand, represent a sizeable pool of tax-free assets.  I also expect that at some point, Congress is going to at least attempt to claw back the tax deduction for municipal bonds.

It is of course true that tax-free retirement savings have a long history in the US.  But they did in Ireland, too, and Ireland is now proposing to tax the bejeesus out of them:

The various tax reduction and additional expenditure measures which I am announcing today will be funded by way of a temporary levy on funded pension schemes and personal pension plans. I propose that the levy will apply at a rate of 0.6% to the capital value of assets under management in pension funds established in the State. 

 It will apply for a period of 4 years commencing this year and is intended to raise about €470 million in each of those years. The levy will not apply to pension funds established here and providing services and benefits solely to non-resident employers and members. Further details regarding the proposed application of the levy are set out in the Summary of Initiative Measures.

0.6% doesn't sound like a lot, but it's a pretty substantial tax on savings: putting money away costs you half a percentage point of your principal every single year.  The document says it's only meant to be temporary.  But for countries in Ireland's fiscal shape, "temporary" taxes have a way of becoming permanent.

This is the sort of thing that desperate governments do when they're having trouble accessing capital markets.  It was easy to write off Argentina's seizure of private pension funds in 2008; to paraphrase PJ O'Rourke, if Latin American finance were a soap opera--and it is--Argentina would be the spendthrift crack-addicted younger brother that uptight, ultra-respectable Mexico fights desperately to save.  

But Ireland is another thing entirely--a model of fiscal rectitude whose budget surpluses were a shining example to the rest of us, now reduced to pilfering its citizens "tax free" private pension funds.  I say this without implied criticism.  When budget deficits soar into the double digits, countries end up doing things they never thought they would.  I don't know enough about Irish finance to know whether this was the best of the available options--but I know enough to know that they don't have any good options left.

And I don't think it's that farfetched that we could end up in somewhat similar circumstances--not exactly the same, obviously, but close enough for discomfort.  If we don't get our deficits under control soon, we're going to get them under control under duress, when the markets are demanding a rising premium to lend to us, and all the choices are hard.  

Ultimately, I see no way around the logic outlined by Tyler Cowen: 

Here's an example: Say that you have $20,000 in Treasury bills. You probably believe that you own $20,000 in wealth. This will encourage you to spend and come up with ambitious plans. Yet someone -- quite possibly you -- will be taxed in the future to pay off the government debt. The $20,000 may be needed in order to do that. 

The illusion is this: A government bond represents both a current asset and a future liability, yet for most people, those future tax payments feel less concrete and less real than the dollars they're holding in a money market account.

The field of behavioral economics analyzes imperfections in market decision-making, but the biggest practical problems often involve our inaccurate perceptions of what the public sector is up to and how much it will affect us. 

In this case, the sorry truth is that our savings aren't worth as much as many of us think, and a rude awakening is coming. One way or another, some of our savings will be taxed away to make good on governmental commitments, like future Medicare benefits, which we currently are framing as personal free lunches.

We can't all enjoy a personal free lunch, and the wealth of the truly wealthy is for many reasons not available to pay for all the benefits we are expecting.  Nor can we simply ratchet up taxes on a working population which is shrinking at both ends as workers stay in school longer, and retire later.

So I think that ultimately retirees are going to end up consuming less than they currently expect to. And given the political economy of it all, I expect the burden to fall more heavily on those who have saved than on those who haven't.