What is “Rothification” and what does it mean to those of us who are saving for retirement? The root word for Rothification is “Roth”, which is a type of retirement plan or IRA where all contributions come from already taxed money. So then, Rothification is the changing of retirement savings from a pre-tax basis to an after-tax basis. The government likes the concept of a Roth because it can get its hands on (i.e., tax) money earlier than it is allowed to with a traditional IRA or traditional retirement plan. Under a traditional plan, contributions are made from pre-tax dollars, and all of the earnings within the traditional plan are tax deferred; the government must wait until you begin withdrawing your savings before it can collect taxes on them.
Imagine that you started saving for your retirement via the traditional TSP 30 years ago in 1991 when you joined federal service. For that entire 30 year period, Uncle Sam (and many state taxing authorities) have been unable to touch that money. When you retire, you will begin to gradually withdraw that money to supplement your FERS annuity and Social Security. The government only gets the tax money a bit at a time over, perhaps, another 30 year period. When it comes to taxes and spending, the government is not big on delayed gratification and there are a substantial number of lawmakers who want to do away with pre-tax retirement contributions.
Early versions of 2017’s Tax Cuts and Jobs Act (TCJA) had provisions that drastically cut the elective deferral amount for retirement plans. The elective deferral amount is the amount that can be deferred from taxes in a traditional retirement plan. Those provisions didn’t make it into the final version of the bill and the elective deferral amount stands at $19,500 today.
There’s more Rothification in the future. Back on May 5th, the House Ways and Means Committee unanimously passed and sent to the full House, the Securing a Strong Retirement Act of 2021. Pundits have referred to this legislation as SECURE 2.0 and Son of SECURE. Those who are as old as I, are waiting for someone to try the moniker SECURE and Gidget Go Hawaiian. What would this Act do if enacted? 1) It would allow SIMPLE and SEP Roth IRAs; 2) It would allow employer matching contributions (in plans like the TSP) to be contributed to Roth accounts. Today, all matching contributions must go into traditional accounts.
Is this trend to Rothification bad? Not necessarily; if withdrawals from Roth plans and Roth IRAs are qualified, there are no taxes assessed on the earnings that have accumulated over the life of the account. In order for withdrawals to be considered qualifying, two things must be true: 1) You must have had the Roth account for at least five years (e.g., if your first contribution was made in 2021, you would meet the five year requirement on January 1, 2026); and 2) You must be at least 59 ½ years old when you withdraw the money.
But wait! Let’s have a show of hands of those readers who believe that Congress will keep promises made to savers in 2021 when it’s 2051 and Uncle Sam is running short of revenue. A future Congress could move to tax, or partially tax, withdrawals from Roth accounts. We need to keep our eyes open and protect our retirement savings.
But there are some things in SECURE meets Godzilla (I’m sure someone will call the Act that before it’s all over), that are without a doubt positive.
• The age for having to take your first required minimum distribution (RMD) would be increased to 75 from 72.
• IRA catch-up contributions (currently $1,000) would be increased annually for inflation.
• Individuals at older ages (60, 62 and others have been floated) will be allowed to make larger catch-up contributions than those between 50 and whatever age Congress agrees on.
• The penalty for failing to take a RMD would be reduced from 50% to 25%.
Remember, however, your high school civics class where you learned how a bill becomes a law. Getting through the House Ways and Means Committee is an early, though important, step in the passage of Son of Secure. If you have any feelings about the proposed changes to retirement savings, don’t hesitate to contact your elected representatives.