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Budget Deal Lets More Savers Switch to Roth 401(k): Taxes
Chuckle, and this in the first year that the critters have access to both a deferred TSP and a Roth TSP instead of just deferred. (TSP is the federal government plan that is like a 401K.)
Your article in combination with Rick Edelman's (an Investment Advisor who sounds off on the radio) rant this morning...triggered a caffeine induced thought...how much money are investment advisors losing as a result of these new Roth conversion options. He thinks this new Roth option is a terrible idea...
"Don't do it!" he screams into the microphone!
I wonder why?
By the articles estimates, tax revenue would increase $12.2 B as a result. This tax increase would be a windfall for the State and Federal coffers (income tax receipts), but it also equates to a 1-2% permanent loss to investment advisors who won't be collecting their management fee off that $12.2B.
This conversion causes $12.2 B to go away premanently (it's taxed away). This is money that otherwise would have grown tax deferred under the management of the investment idustry who now cannot collect their tax. In other words, it is now a loss in revenue of $12-25 Million dollars...this, to me, is the real reason why you will hear that this new rule is such a bad idea...an especially bad idea for the high fee investment management industry that is.
Reply to @bee: The money doesn't permanently go away, only temporarily. As pointed out in the article:
"Every dollar of that $12 billion is revenue that the federal Treasury would have collected in subsequent decades," Greenstein wrote in a post on the center’s website. “The resulting revenue loss in later decades will be substantially greater than $12 billion -- probably several times that amount.”
It means that down the road, taxpayers who take advantage of this opportunity will wind up in the long term with more, not less, money to invest.
As I wrote in a comment to the CBPP column linked to by this article (Budget Deal Gives New Tax Cut to Wealthy – And Pretends It’s a Tax Increase) - this is primarily a gift to the affluent. That's not to say that in limited doses Roth conversions can't help others, but the bulk of the benefit goes to those who max out their contributions, who will still have significant income in retirement. That's not your average Joe, and that's why advisors are (or at least I hope are) suggesting people take a close look before jumping on this.
Reply to @msf: Maybe I'm missing something, but this is how I see the impact of early tax collection (due to a Roth Conversions) on management fees compared to fees collected from tax deferred investments.
If I convert a 401k to a Roth 401k I pay taxes in the year it is converted. The money needed to pay these taxes should come from funding sources outside of the 401k. If the funding source comes from within the 401k it would trigger early withdrawal penalties as well as the tax bill...not a smart move.
So let's assume that the funding source is part of a taxable investment account that most likely is a "managed account" much like the 401k where fees are collected. Since the funding source has now been dinged to the tune of the tax bill this "tax bill redemption" is no longer is availabe to be managed therefore no managment fee can be collected on the money that was permanently taxed away.
My point is that these Roth conversion trigger immediate taxation removing money that would have otherwise grown tax deferred and charge an ongoing management fee. Taxing due to a Roth conversion makes the money "go away" from the stand point of Assets under management from the investment company perspective.
Reply to @bee: Yes, fewer assets now, but more assets down the road, because the IRS ultimately gets less, forever. That means that the management companies, like the taxpayers, come out better in the long term. Of course, management companies live forever and can bide their time, while advisors don't - they're the ones who would care more about the short term loss.
If your theory about the management industry were the reason they're taking conservative position on Roth conversions, you'd be hearing the same thing from the industry about Roth contributions (i.e. IRA Roths, 401K Roths). After all, it's the same argument - if you contribute to a Roth rather than to a pre-tax account, then you have to take money to pay those taxes and you'll have less to invest, and thus less money (in the short term) for the management company to skim. But the management companies seem to have been screaming about how wonderful Roths are from the day they were created.
I return to my thesis that Roth conversions (whether in IRAs or 401Ks) primarily benefit those who max out their contributions, and the last time I checked, that was only about 5% of households.
Good points...thanks for your links and thoughts on the topic. Also, one could argue that a Roth account often is the last "pot of money" tapped into due to its unique features supporting your point that these investments will grow for potentially a longer period of time possibly even over two lifetimes if the Roth is inherited.
Comments
"Don't do it!" he screams into the microphone!
I wonder why?
By the articles estimates, tax revenue would increase $12.2 B as a result. This tax increase would be a windfall for the State and Federal coffers (income tax receipts), but it also equates to a 1-2% permanent loss to investment advisors who won't be collecting their management fee off that $12.2B.
This conversion causes $12.2 B to go away premanently (it's taxed away). This is money that otherwise would have grown tax deferred under the management of the investment idustry who now cannot collect their tax. In other words, it is now a loss in revenue of $12-25 Million dollars...this, to me, is the real reason why you will hear that this new rule is such a bad idea...an especially bad idea for the high fee investment management industry that is.
Regards,
Ted
http://online.wsj.com/article/SB10001424127887323689604578219570173772406.html?mod=WSJ_Markets_LEFTTopStories#printMode
The money doesn't permanently go away, only temporarily. As pointed out in the article:It means that down the road, taxpayers who take advantage of this opportunity will wind up in the long term with more, not less, money to invest.
As I wrote in a comment to the CBPP column linked to by this article (Budget Deal Gives New Tax Cut to Wealthy – And Pretends It’s a Tax Increase) - this is primarily a gift to the affluent. That's not to say that in limited doses Roth conversions can't help others, but the bulk of the benefit goes to those who max out their contributions, who will still have significant income in retirement. That's not your average Joe, and that's why advisors are (or at least I hope are) suggesting people take a close look before jumping on this.
Maybe I'm missing something, but this is how I see the impact of early tax collection (due to a Roth Conversions) on management fees compared to fees collected from tax deferred investments.
If I convert a 401k to a Roth 401k I pay taxes in the year it is converted. The money needed to pay these taxes should come from funding sources outside of the 401k. If the funding source comes from within the 401k it would trigger early withdrawal penalties as well as the tax bill...not a smart move.
So let's assume that the funding source is part of a taxable investment account that most likely is a "managed account" much like the 401k where fees are collected. Since the funding source has now been dinged to the tune of the tax bill this "tax bill redemption" is no longer is availabe to be managed therefore no managment fee can be collected on the money that was permanently taxed away.
My point is that these Roth conversion trigger immediate taxation removing money that would have otherwise grown tax deferred and charge an ongoing management fee. Taxing due to a Roth conversion makes the money "go away" from the stand point of Assets under management from the investment company perspective.
Less assets to manage...less fees to collect.
If your theory about the management industry were the reason they're taking conservative position on Roth conversions, you'd be hearing the same thing from the industry about Roth contributions (i.e. IRA Roths, 401K Roths). After all, it's the same argument - if you contribute to a Roth rather than to a pre-tax account, then you have to take money to pay those taxes and you'll have less to invest, and thus less money (in the short term) for the management company to skim. But the management companies seem to have been screaming about how wonderful Roths are from the day they were created.
I return to my thesis that Roth conversions (whether in IRAs or 401Ks) primarily benefit those who max out their contributions, and the last time I checked, that was only about 5% of households.
Good points...thanks for your links and thoughts on the topic. Also, one could argue that a Roth account often is the last "pot of money" tapped into due to its unique features supporting your point that these investments will grow for potentially a longer period of time possibly even over two lifetimes if the Roth is inherited.