Roth IRA disadvantages

[dh003i]

After reading All You Ever Wanted to Know About Roth IRAs But Were Afraid to Ask, I'm wondering about protection issues regarding Roth IRAs. Specifically:

• Is a Roth IRA protected from the claims of creditors?
  
• Is a Roth IRA protected from the effects of bankruptcy?
  
• Is a Roth IRA protected from lawsuits?
  
• Is a Roth IRA protected from divorce judgements?
  
• Can Congress retroactively revoke the tax-free status of earnings in a Roth IRA? If they can retroactively extend copyright laws, why not retroactively extend taxes?
  
• Are the earnings in Roth IRAs exempt from taxes other than the capital gains tax, like state and local taxes? If they are, could states retroactively revoke those exemptions?
  

I looked around on the web for information on this, but not much was helpful, other than some vague references. Regarding most of these, I believe that it is dependant on State Law. All states provided most of the above-mentioned protections for Traditional IRA's, but may not have updated their legislation to provide those protections for Roth IRAs. I even tried LexisNexis, but that gave me results that didn't appear to have anything to do with Roth IRA's. Specifically, I'm interested in NY laws, but those in other states may obviously be interested in the laws of other states.

[John G]

I will respond to points 5 and 6:

"Can Congress retroactively revoke the tax-free status of earnings in a Roth IRA? If they can retroactively extend copyright laws, why not retroactively extend taxes?

Are the earnings in Roth IRAs exempt from taxes other than the capital gains tax, like state and local taxes? If they are, could states retroactively revoke those exemptions?"

Can Congress - sure they can... but in my opinion they would have a combination of problems with any direct changes as taxes were paid and unless they turn accounting rules upside down they would have a problem with "basis". Congress would have a major rebellion on their hands as some heads would roll over reneging on the rules. As more and more people have Roths, there is greater protection in large numbers. Think AARP and senior issues.

States - treatment varies from state to state, but many states use the information on specific lines of the 1040 as the basis for their taxable income. If it is not reported on the federal form, in these states it doesn't show up on their tax forms. Sure they can change the rules... but States would have the same problems outlined above.

There are no 100% guarentees. I think the basic elements of the Roth are currently going to hold. If changes are made, the existing Roth assets would probably be grandfathered under the old rules. It is more likely that any erosion of Roth value would be done indirectly through failure to modify the AMT. The most recent trend is towards expanding and relaxing rather than narrowing or eliminating these kinds of retirement options.

[mbozek]

It is highly unlikely that Congress would retroactively revoke the tax benefits of a Roth IRA for contributions made in prior years. What could happen is that Congress would prospectively curtail the benefits of a Roth IRA for persons in higher income groups for future contributions as was done with the universal IRA after 1986. From 1982-86 all taxpayers could make tax deductible IRA contributions. However, after income tax rates were reduced under Tax Reform Act of 1986, only taxapyers who are not participants in a qualified plan or whose AGI is below certain limits could make a deductible IRA contribution.

Under the principle of federalism, states are free to tax roth IRA earnings. Some states (NJ and PA) do not allow for state tax deductions for deductible IRAs. Most states do not tax roth IRA earnings but you should consult your tax advisor for rules of a specific state or check the state tax site on the internet.

Whether a Roth IRA is subject to creditors is also a matter of state law. Virtually all state divorce laws consider a Roth IRA to be property subject to division in divorce if it was acquired during the marriage.

[John G]

Good additions Mbozek...

I thought of one additional thing. "State" is an issue when contributions are made, where you live at the time of a conversion and where you live when you withdraw funds. Ideally you would want to do a conversion in a state with favorable tax treatment and withdraw in a state with favorable tax treatment. They may not be the same state..... just to make things a little more complex. There are about 8 states that do not have income taxes.

[dh003i]

Regarding Congress retroactively eliminating the benefits of Roth IRA's, what worries me is that they even have the possibility of doing this. I'm no lawyer, but in my simplistic civillian mind, it seems obvious that retroactive laws are bad and seem inconsistent with the Constitution and Amendments. Yet, the USSC has supported them (see DMCA). So, the question is, what legal deterrents could there possibly be to Congress retroactively eliminating the advantages of Roth IRAs?

Regarding the vulnerability of Roth IRA's, waht I'm really concerned about here is if they are vulnerable to creditors when you file for bankruptcy, or lawsuit judgements. This wouldn't be an issue if you could just roll them over into a normal IRA (which is protected by all state laws, I believe)...but some law regulates that if a transaction is deemed as being done for fraudulent reasons (e.g., to avoid paying a lawsuit judgement, or creditor) it can be unrolled and undone.

So, the issue here is how does on protect one's assets in a Roth IRA from these kinds of threats. If anyone knows of anyplace where the applicable state-laws can be found, it'd be useful. Furthermore, if anyone knows of any strategies to protect assets in a Roth IRA from these kinds of threats, that would also be useful.

[david rigby]

Congress giveth, and Congress taketh away.

At least for now, a qualifed plan provides certain protection not available to an IRA.

[John G]

DH, you seem to be worrying about the wrong things. The single most important defense against bad behavior by government is our faith in "the people" and reasonableness. The Jimmy Stewarts outnumber the bad guys 1000x to one. If Congress starts to renege on their promises, the system breaks down, distrust grows and all sorts of negative things like tax compliance start to collapse. If the actions get too personal, politicians run the risk of someone using a weapon in lunatic attack. (think George Wallace among many)

I normally tell folks that they have little to fear from terrorism, the probability of being effected is far less than dieing in a car accident or in a medical treatment mistake. For you, I recommend that you substitute worry about these things then worry about Congress retroactively changing IRAs. If that does not work, try global warming, over population, ozone holes, ocean pollution or any other real threat. Folks worried about the impact of creditors and divorce on their IRAs might redirect the efforts into doing something to pay their creditors and make their marrage work.

I would not spend a lot of time being concerned about retroactive Congressional rules. Things change incrementally. The SSN retirement age for example.

[dh003i]

A follow-up note. After inquiring through a legal firm in New York, I have found that Roth IRAs -- at least in New York -- are exempt from lawsuite (other than divorce) and thus exempt from the claims of creditors. RothIRAs are exempt from the judgement in a lawsuit, because they are considered a public or private pension, and public or private pensions are exempt from lawsuit claims. In this regard (public/private pension), there is no distinguishment between a Roth IRA and a traditional IRA.

Thanks to Tim Spoele of Feldman, Cramer, and Monaco for finding that information for me.

[Guest REIL guy]

Hey I am new to this group but I have been looking into your question. It is true about the New York fact, however, there is a bill in the Senate right now that proposes that all IRA's and their assets be protected under a bankruptcy. The bill is titled HR 975. I hope this helps.

[jevd]

The bill has passed the House and has been read twice in the Senate. It is on the Senate Calender and has been since March. It is part as stated above of a Bankruptcy reform bill. It had many co-sponsors in the House. You may check the status by going to thomas.loc.gov and searching for HR 975.

By the way, for all of you newbies who wish to track legislation, this is a great site. Its also a great place to educate yourself on the legislative process.

Complete address below

http://thomas.loc.gov/

[mbozek]

dh003i: NY law does not exempt additions to an IRA account which accrue after a date that is 90 days before the interpositon of a judgement from the claims of creditors. CPLR 5205©(5). Any amounts added to a Roth IRA (e.g. earnings) after that date are subject to the claims of creditors.

[dh003i]

dh003i: NY law does not exempt additions to an IRA account which accrue after a date that is 90 days before the interpositon of a judgement from the claims of creditors. CPLR 5205©(5). Any amounts added to a Roth IRA (e.g. earnings) after that date are subject to the claims of creditors.

Thanks for noting the exception. This is a good reason why people should put as much money as they can into a Roth IRA now, not later. It's important to engage in asset protection before you're sued, because -- even without the NY state exception -- your transactions can be undone if a court thinks they were done for fraudulent purposes (and clearly, placing money that would otherwise go to a ruling into a Roth IRA is for fraudulent purposes).

If you are interested in asset protection in general, you may want to visit this e-book.

Regarding the new bankruptcy law, it is a mixed bag, which curtails the priviledges afforded debtors in some areas, and curtails the tactics used by creditors in others. The inclusion of the Roth IRA in protection is good, however. It's worth giving the proposed legislation a read. And it's always amusing the hear the government talking about giving counsel to those who go bankrupt, so that they can "better manage their money and not go into debt".