Tax Guru – Ker$tetter Letter

Q:

Subject: Fair Tax & Roth accounts?

How is the Fair Tax supposed to integrate with Roth accounts? These are *supposed* to be tax-free upon withdrawal. The Fair Tax represents a very large stealth tax increase on these accounts.

A:

There’s no way to make such a radical change in the tax system without also affecting the results of tax motivated transactions. 

This is why I have always been critical of plans by people to convert conventional IRAs to Roths.  Paying real tax money now for promised tax savings down the road has never felt like a good idea because there is no guarantee that the tax free aspect will survive the whims of our rulers in DC.  While I do support the concept of the FairTax, I’m not as worried about it messing up Roth IRAs as I am about our rulers instituting a means test for taxation of Roth IRA income in the same way they did for Social Security recipients.

Thanks for writing.

Kerry Kerstetter

Follow-Up:

I did it because (a) I had relatively low tax cost since I converted during a year when I was unemployed, and (b) I won’t be making any more contributions to the account. You’re right about their tendency to take away what they have given when their lack of restraint catches up to them. I shudder at the thought of  Hilary as President and a Democrat-majority Congress.

 

A means test? That would be horrible! Of course, that wouldn’t raise the kind of revenue the IRS expects. The means test only screws middle-income taxpayers. Low income (though with non-indexed income thresholds this becomes progressively less meaningful) people won’t be affected, assuming they even have a Roth account, and people with plenty of non-Roth income won’t have to take distributions. To give means testing real sharp teeth you’d need to make Roth IRAs subject to RMD.