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You Can't Change
the Rules Midgame

September 29, 2014

A recent budget proposal by the White House includes a major change for Roth IRAs – named for former Senator William Roth (R-DE).  The proposed changes will likely destroy this important investment strategy and impact a countless number of people from your neighbor across the back fence to even you.  

At their inception ROTH IRAs required the investor to pay the tax up front.  In return, the government by law granted several important privileges.   One writer described their features  this way.  

"With a Roth IRA, you contribute money that's already been taxed.  Any earnings in a Roth IRA have the potential to grow tax-free as long as they stay in the account. Withdrawals of earnings from Roth IRAs are federal income tax-free and penalty-free if a five-year aging period has been met and the account owner is age 59½ or over, disabled, or deceased. Roth IRAs are not subject to minimum required distribution (MRD) rules during the lifetime of the original owner, so you can leave your assets in the Roth IRA where they have the potential to continue to grow."

The ROTH approach created several advantages:  First the government collects its tax much earlier at generally higher rates.  Second, the complete immunity from future taxation of principal and earnings has proved to be a reliable safe haven for small investors while creating significant investment capital -- a win-win for government and the free market alike.

Now comes a White House budget proposal that seeks to undo the promises made to investors and the benefits to the economy.  Hidden deep in the proposed budget details for 2015, the White House included several changes for ROTH IRA's.  Two of the changes will significantly change their value.  The Administration proposal would subject ROTHs to the minimum distribution rule meaning that after age 70.5  forced distributions into taxable accounts would be required.  From a financial viewpoint, this has an element of double taxation because the money originally invested would then become subject to yet another tax.  Second, the 2015 proposal includes a maximum value limit.  This significantly changes how much can be passed to heirs.  The practical effect of the White House proposal is that the ROTH IRA will disappear along with the benefits to small investors and the government..  

As a child, did you ever play a game with your friends and one of them changed the rules to favor themselves in the middle of it?  This is exactly what the 2015 White House budget proposal would do because it purposefully fails to include grandfathering.

 So why is this a patently unfair and damaging practice?  First, without raising the ire of the electorate over increasing taxes, it raises taxes and perhaps significantly.  Second, income from these investments will be taxable under the [Un]affordable Health Care Act provisions.  Lastly, this approach lines up with the Administration’s worldview that the “rich” (including those small investors who have their entire life savings tied up in ROTH IRAs) must pay significantly more taxes.  

This is a dangerous precedent that must not stand, because if the government can change the rules retroactively then nobody's investments are safe. One of the basic tenets of freedom is the right to own private property (something owned; that the government is not allowed to take without due process of law).  In the long run, using back door or hidden approaches to implement one’s own beliefs only causes damage and ultimately destroys freedom.  As a nation, we cannot allow changing the rules in midstream.  If we do, we all lose, including the rule changers.

Mark, John and Bill