Can the Government Decide to Tax Roth Accounts?, #137
Listeners of the show know I love utilizing Roth accounts for retirement savings when it makes sense for the given situation. But one listener is concerned that the government will decide to start taxing Roth distributions after years of building up their Roth 401k. On this episode, I’ll give you my take on the taxability of Roth accounts as well as helpful retirement savings information for those who use them.
You will want to hear this episode if you are interested in...
Will Roth accounts be taxed? [1:29]
Exploring the taxability of matching Roth 401k contributions [5:33]
How the Secure Act 2.0 changed the catch-up contribution for Roth accounts [6:52]
Final thoughts [10:29]
Getting down to brass tax
Studies show a roughly 30% increase in companies offering the Roth 401k as an option for employees to save for retirement. Many people take advantage of Roth accounts for their obvious benefits. Mainly the fact that Roth accounts are not pre-tax accounts. Meaning you pay taxes on any money you put into a Roth account upfront, that money grows tax-deferred while it sits, and then you can withdraw the money tax-free. It’s a great way to save for retirement if you don’t want to worry about taxes on the back end. But this sweet setup has one listener wondering if Congress could decide to pass laws requiring Roth account distributions to be taxed?
The short answer is yes. The U.S. government could pass any law it wants. There’s also a precedent for it, considering Social Security was not taxable until Congress voted to change it in the 80s. However, while a similar change to Roth accounts is possible, I do not believe it’s likely. Traditional retirement accounts are tax-deferred, so the government has to wait until the money is distributed to get their tax revenue. Considering where the national debt is at, it feels unwise to attack an option that gets the U.S. Treasury its money upfront.
Recent congressional changes to Roth accounts
Another reason I think it’s unlikely that the government will choose to tax Roth accounts on the back end is all of the positive changes made towards them in the recently passed Secure Act 2.0. One positive step for Roth 401ks is that you can now receive the vested amount of your 401k match for the Roth account into the Roth account. Previously, employer match contributions had to be placed into a traditional 401k even if the initial contribution was put into a Roth. Those looking to take advantage of putting matching contributions into a Roth 401k should remember that Roth accounts are not pre-tax accounts. So any contributions, including matching ones, will need the tax paid upfront.
Additionally, the Secure Act 2.0 made a significant change for catch-up contributions, which allow people over 50 to add up to $7,500 to their standard 401k contribution of $22,500. Starting in 2024, if you are an employee that earns over $145,000, you will not be able to make the catch-up contribution on a pre-tax 401k basis. However, catch-up contributions can still be made to a Roth 401k with the taxes paid upfront. For more on the taxability of Roth accounts, listen to this episode!
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