Broken Promises: Roth IRAs and HSAs

Posted On Apr 25, 2019 By Dave Gonigam

  • Congress moves to kill the “stretch IRA”
  • Could the Roth IRA be next?
  • And what about health savings accounts?
  • U.S. industry is both booming and collapsing today
  • Facebook’s cost-of-doing-business fines
  • A defector from the cult of Tesla
  • Reader request: The 5 fact-checks itself

The federal government reserves the authority to change the rules of retirement at any time. And the rules may be about to change again.

Decade after decade, Uncle Sam makes promises… and breaks them.

In the 1930s, the architects of Social Security would have never dreamed of imposing income taxes on Social Security benefits. But by the 1980s, the Greenspan Commission thought it would be a fine way to shore up Social Security’s finances.

Nowadays, depending on how well-off you are, up to 85% of your benefits count as taxable income.

More recently, the Obama White House connived with the Republican Congress to kill the “file and suspend” strategy many couples used to maximize their Social Security benefits.

The next promise Washington is set to break is the one about the “stretch IRA” strategy to create a prosperous future for your heirs.

Buried in a bill that just passed the House Ways and Means Committee is a clause that would speed up the process of taxing IRA inheritances given to heirs other than the spouse of the deceased.

Here’s how the system works now, as described by Agora Financial analyst Nilus Mattive: “When someone other than your spouse inherits your IRA, they face two basic choices:

  1. Withdraw the whole amount by Dec. 31 of the fifth year after your death
  1. Begin receiving minimum distributions based on their own life expectancy.

“Say you die this year and leave your Roth IRA to your son who is 53. If your son decides to take minimum distributions, the IRS will use its actuarial tables to figure out roughly how long your son is likely to live.

“Then the IRS will divide the value of your account by that number (31.4 this year) to arrive at a dollar amount for yearly distribution. In the case of a $100,000 portfolio, your son would have to withdraw $3,184 next year ($100,000/31.4).

“Now, look into the future many years. While your son is taking those minimum distributions, the value of his inherited investment account can continue to rise!”

But not if this new legislation becomes the law of the land. The government wants the revenue sooner rather than later.

“Nonspousal beneficiaries would have to take out all the money within 10 years,” Nilus explains. “The Senate version of the bill forces all distributions to occur over five years if the account is worth more than $400,000. There are just a few small exceptions for minor children of the account owners and disabled beneficiaries.”

We’ll keep an eye on the progress of this bill…

What promises might be broken next? Let’s talk about your Roth IRA.

“I no longer believe lawmakers will honor the promises they’ve made regarding Roth IRAs,” Nilus wrote three years ago.

“At the very least, I believe Washington will eventually alter the law so that Roth IRA beneficiaries can no longer withdraw their inheritance over their lifetimes — which was one of the primary reasons I was recommending rolling over assets from a traditional IRA to a Roth.

“Moreover, I believe it is also becoming far more likely that politicians will eventually remove the tax-free benefit on earnings within Roth IRAs… at least for wealthier Americans.”

Again, that was three years ago. Fast-forward to the present: “Here we are, and phase one is already happening,” says Nilus. “Does phase two seem so outrageous, especially when you listen to some of the things being floated by some far-left politicians?”

“Holders of Roth IRAs may be in for a rude shock,” warned Steve Forbes as long ago as 2013.

“Their contributions have been made with after-tax dollars, with the promise that the ensuing benefits would be exempt from federal income tax. Slapping a special ‘emergency’ levy on these assets will become an irresistible temptation for politicians as the pot of assets gets bigger.”

In 2012, Time magazine’s personal finance columnist Dan Kadlec saw something similar in the works, if not right away: “A retroactive tax on this sheltered income has been a worry from the start. And now these accounts have a meaningful total — and everything is on the table.”

The chatter back then was such that we offered the following guidance to readers of the gone-but-not-forgotten Apogee Advisory: Don’t put new funds into Roth accounts, and don’t convert regular 401(k)s and IRAs to Roths. “Use conventional 401(k)s and IRAs instead,” said our executive publisher Addison Wiggin, “and grab the tax savings now, while you still can.”

Speaking of “take the money and run,” let’s talk about health savings accounts. Because the same dynamic is at work.

HSAs are growing in popularity — and not just because your contributions can roll over and build up year after year (unlike the “use it or lose it” FSA).

As you might know, the beauty of HSAs is that they’re “triple tax-free.” Your contributions aren’t taxed. The interest and capital gains aren’t taxed. And your withdrawals aren’t taxed as long as you spend them on “qualified” health care expenses.

HSAs are such an attractive savings vehicle that some people take them to extremes: They won’t draw on their HSA to pay for current out-of-pocket medical expenses, preferring to let their account balance grow tax-free as much as possible.

In theory, this is a sound strategy: Under the rules, you could pay out-of-pocket expenses from after-tax funds this year and then put in for reimbursement from your HSA many years later — as long as you keep good records and the expenses were incurred after you established the HSA.

In practice, however, you’re counting on Uncle Sam not to change the rules. And as with Roth IRAs, the pot of HSA money is probably too large for Uncle Sam’s grubby hands to resist.

Especially because in Washington, the knock on HSAs is that they mostly benefit “the wealthy.” According to Americans for Tax Reform, Sen. Bernie Sanders’ “Medicare for All” proposal would do away with HSAs altogether. (How would that work, exactly? Would your entire account balance become taxable income in a single year? Ouch.)

In the end it’s your call. But given Washington’s track record, it makes sense to draw on your HSA for current-year medical expenses — and grab all the available tax advantages now before they’re potentially taken away from you.

This morning, it’s the best of times and the worst of times for U.S. industry.

The Commerce Department issued its monthly report on orders for durable goods — everything designed to last three years or longer, from dishwashers to diesel generators. The number jumped 2.7%, way more than expected.

The number is still solid once you strip out orders for aircraft and military hardware, which vary wildly from month to month. Orders for “core capital goods” jumped 1.3%, also way more than expected. The manufacturing sector as a whole is turning in its strongest performance since last fall.

On the other hand… the industrial stalwart 3M turned in a miserable earnings report before the open. Sales fell year over year… and the company downgraded its outlook for the rest of 2019. At last check, MMM shares are down more than 10%.

The gloom with 3M has spread to the rest of the Dow Jones industrials — which are down nearly 1% as we write, around 26,350.

But the loss with the S&P 500 is more modest, about a quarter percent. And the Nasdaq is in the green, if only slightly.

Helping the Nasdaq is that two of its biggest technology companies delivered market-pleasing earnings reports.

Heck, Microsoft is up nearly 4% on the day… and verging on that rarefied territory of a trillion-dollar market cap that Apple and Amazon had for a while last year.

Meanwhile, Facebook is up 6% this morning after announcing a 26% rise in first-quarter revenue.

The fact FB also set aside $3 billion to cover federal penalties for privacy violations? Chump change. Reminds us of the cost-of-doing-business fines the banks were paying a few years ago…

And then there’s Tesla — which critics will remind you is not a technology company, it’s a car company. And cars are notoriously capital-intensive to produce.

Going into the release of Tesla’s numbers after the close yesterday, the mood was, well, grim…

hipster tweet

In the event, TSLA reported a loss of $2.90 a share — just a little more than the Street’s guess of “only” $1.15. On the conference call, founder and CEO Elon Musk conceded he might need to raise more capital. Whether that would be in the bond market, or via issuance of new stock, or the Tooth Fairy, he didn’t say.

For at least one longtime TSLA bull — Daniel Ives from Wedbush Securities — it’s too much. This sentence is hard to follow, but you get the gist: “In our 20 years of covering tech stocks on the Street we view this quarter as one of top debacles we have ever seen while Musk & co. in an episode out of The Twilight Zone act as if demand and profitability will magically return to the Tesla story.”

But cults die hard: TSLA is down a mere 2.5% this morning. At $252, shares are no lower now than they were in early October. It’s mind-boggling…

“It would be more relevant and credible,” writes one of our regulars after yesterday’s 5, “if sources were included with your statements like:

The White House is weighing the interests of major Trump donors who loathe Iran — like the casino magnate Sheldon Adelson and the hedge fund manager Paul Singer — versus the interests of the American driving public.

“But,” he adds… “I love The 5!”

The 5: The journalist Eli Clifton has done yeoman’s work following the money.

In 2016, “Adelson, for his part, was Trump and the GOP’s biggest campaign supporter,” Clifton wrote last year. “He and his wife, Miriam, contributed $35 million in outside spending to elect Trump, $20 million to the Congressional Leadership Fund (a super PAC exclusively dedicated to securing a GOP majority in the House of Representatives) and $35 million to the Senate Leadership Fund (the Senate counterpart) in the 2016 election cycle.”

You don’t contribute that kind of money without expecting something in return. We can only hope Trump doesn’t follow through on Adelson’s suggestion in 2013 that Washington launch a nuclear strike against Iran just to say, as Adelson put it, “We mean business.”

Trump’s No. 2 donor was Home Depot co-founder Bernie Marcus, who told Fox Business in 2015, “I think Iran is the devil.” According to Clifton, Marcus “contributed $7 million to pro-Trump Super PACs, $500,000 to the Congressional Leadership Fund and $2 million to the Senate Leadership Fund.”

As for Singer… he wasn’t a Trump fan at the outset, but he wound up kicking in more than $1 million for the inauguration. Singer gives generously to the Foundation for Defense of Democracies, which spends the bulk of its time these days advocating for ever-tougher measures against Tehran. Marcus gives FDD even more.

Is there a conscious calculation within the White House about pleasing the donors with an Iran oil embargo versus placating the motoring public with lower fuel prices? Maybe, maybe not. But that’s the choice the administration is exercising nonetheless.

And that’s just the short-term choice. Longer term, the choice comes down to a vendetta against Iran versus the U.S. dollar losing its status as the globe’s reserve currency. We’re certain the administration isn’t thinking that through…

P.S. Back to Facebook’s numbers: Ten days ago, Alan Knuckman’s weekly profit indicator was signaling a big bump coming for FB… and he recommended an options trade.

Yesterday he said it was time to sell half that position… and today his readers were filled on that trade for gains of 127%. The other half might well soar higher before expiration in three more weeks.

Alan’s next trade recommendation is due Monday. Until then, we’re extending a special offer on his Weekly Wealth Alert service. Details from our customer care director at this link.


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