If you put money into a traditional IRA or 401k, that much of your income is sheltered from taxes — until you retire, and then you have to include withdrawals from your retirement accounts as potentially-taxable income.
But if you put money into a Roth IRA or 401k, it’s the other way around. You pay taxes on the money you earned and put into the accounts in the year you earn it, but then, when you withdraw from your Roth accounts in retirement, you get the money tax-free.
At least, that’s how it’s supposed to work. In setting things up this way, Congress made an implicit promise that the Congresses of the future won’t change the law to tax all of your Roth money a second time when you withdraw it. And Congress doesn’t have the power to bind future Congresses like that. Future Congresses are going to be scrambling to find money to pay off all the wars, bailouts, benefit programs, and so forth that today’s Congresses are authorizing but neglecting to fund.
So there’s good reason to expect that they’ll play the ol’ switcheroo. In fact, they’re already plotting:
The U.S. Congress has created a situation in which, after 2010, there may be a significant number of taxpayers holding an enormous amount of wealth the return on which they will claim should be permanently exempt from tax. This paper examines the policy choices available to Congress should it come to regret having allowed the creation of these tax-prepaid accounts. It focuses first on the general nature of traditional retirement accounts, and the ways in which Congress has and could be expected in the future to alter the terms of these accounts. It concludes that Congress should feel free to change the tax treatment and other terms of these accounts in ways that might significantly affect the value of existing accounts, just as it should feel free to change the tax treatment of any other asset or investment position. It then considers whether there is anything different about the tax pre-paid IRAs, especially those that are converted traditional IRAs. It concludes that although the claims of the holders of these accounts are qualitatively different from the holders of other tax-preferred investments, they should not be viewed as sufficiently different to render such accounts immune from any change. Nevertheless, the potential power of these claims suggests that Congress should avoid creating them in the first place.
Don’t say I didn’t warn you.