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Roth IRA Phaseout Makes No Sense

Posted By Jim On 05/11/2007 @ 9:45 am In Retirement | 18 Comments

I can understand why certain things in our tax structure have phaseouts, like who is eligible for the earned income credit and who is permitted to take what deductions, but the phase out for the Roth IRA simply doesn’t make much sense.

The general purpose of a phaseout is so that only a select few are able to take advantage of something because they are perceived to need the help. In the case of the earned income credit, it’s designed to help those with low incomes and so it makes sense that you must earn under a certain amount to qualify. In the case of some deductions, such as the mortgage deduction if your home is less than $1M, it makes perfect sense because folks who own multi-million dollar homes don’t need an extra hand with homeownership. If they did, they would’ve bought a more modest home.

But it’s the Roth IRA… it’s sole purpose is to give you some tax diversification by allowing you to save $4k a year and have it grow tax free. The money is taxed before it enters the IRA, so the rich get do not get a bigger benefit (in fact, they pay more for the benefit of a Roth IRA because their marginal tax rate is higher). Is the government saying that the rich don’t need tax free growth? The Roth IRA is only a better choice over a Traditional IRA if your marginal tax rate is higher when you’re retired – when is that more likely, when you’re making a lot of money now or when you’re making a more modest amount now? I’d say the latter but those in the former group don’t have a choice in contributing (or is the government protecting the rich from themselves? conspiracy!)

So why do you think is the reason or reasons why the phase out exists?


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