Buying Your Way Around Roth IRA Contribution Limits?

Buying Your Way Around Roth IRA Contribution Limits?

Here’s a thought exercise for you…

One of the main reasons to choose a Roth IRA over a traditional IRA is that you can pay taxes now in return for tax-free distributions later. This is also good from the Federal Government’s perspective, as it allows them to collect taxes right now vs. sometime down the road.

In fact, the elimination of income limits for making traditional-to-Roth IRA conversions, along with the fiscal cliff legislation paving the way for in-service traditional-to-Roth conversion in qualified plans are both excellent short-term revenue generators — again, at the expense of collecting more taxes down the line.

So that got me to thinking. If the Feds are so keen on raising revenue today without much though for the future consequences, why not allow people to effectively buy higher Roth contribution limits?

As things stand, the penalty for excess contributions is 6%/year until the money is removed. That’s onerous enough that people won’t put in extra as an investing strategy. But if they found a more reasonable (and non-recurring) price point, they could generate a ton of extra cash buy letting people pay a premium to stash extra cash.

What would a reasonable price be? I’m not sure. You’d have to make it attractive enough to investors that they’d do it without completing mortgaging the future. Then again, Congress has never been averse to mortgaging our future, so perhaps that’s not an issue.

It would also be important to keep a somewhat level playing field — it wouldn’t be fair to let high income earners dodge their higher tax rates for the same price as lower income earners with lower tax rates — so perhaps the price would have to vary depending on your marginal tax bracket.

So, dear readers, what do you think? Would you be willing to pay a premium to stash extra money in a Roth IRA? If so, how much?

Keep in mind that your contributions are already subject to income taxes — what I’m talking about is an amount on top of that for any dollars in excess of the prevailing contribution limit.

19 Responses to “Buying Your Way Around Roth IRA Contribution Limits?”

  1. Anonymous

    Actual, there is an existing way to ‘overcontribute’ to a Roth IRA. If your company allows for after-tax (not the same as Roth 401k) contributions to your traditional 401k, those funds can be rolled into a Roth IRA. Some 401k administrators may even allow in-service withdrawals (meaning while you’re still working). I’ve considered doing this but the employer match is temporarily suspended if I do an in-service withdrawal.

  2. Anonymous

    With the extremely high penalties on IRA over contributions today, there is no good reason to over contribute.

    But, if the penalties were lowered (as Nickel suggests), I’m sure it would create a market for someone to bite.

    As for me, even if the penalty was $0, there still isn’t a financial advantage to use a Roth. If the goal is to increase revenue today, congress should just get rid of tax deferred retirement accounts (and watch as world stock markets crash overnight, since demand will evaporate).

  3. Anonymous

    Interesting perspective, very interesting.

    See, I come at it from a completely different angle: people are willing to pay for anything that there is a demand for. So, at that point you just have to make sure the supply meets the demand. So, if you take a look at – that’s the perspective I’m tackling it for.

    Theortically, sure, I’m willing to pay 1-3% on my base on a recurring basis to avoid a higher tax rate on my earnings in the future. At that level, it’s almost like you’re paying an extra management fee to have tax exempt earnings. And, in the long term, as along as your return has a norminal return rate assures that your surcharge is less than the taxes avoided at a compounded rate then it is definitely worth it. And, see, that’s why I suggested Chained CPI or a percenage like that as the surcharge on the base annually: your earnings compound and the surcharge isn’t on your earnings.

    Anyways, two different persepectives.

  4. Frank: For the same reason they offer the Roth in the first place, and that abolished the income limits for converting to a Roth IRA back in 2010, and that they’ve loosened the rules for in-service Roth conversions on qualified plans as part of the fiscal cliff legislation.

    Don’t underestimate Congress’ willingness to sell out tomorrow in the name of revenue today. They’re not trying to maximize revenue overall. They are trying to maximize revenue *today*, even if that comes at the expense of tomorrow. Nobody in their right mind would pay on ongoing fee to put extra money in a Roth unless it was really, really low. Also, the tracking would be almost impossible b/c the “legit” funds would be commingled with the “extra” funds.

    But people *might* consider paying a one-time penalty (or fee, whatever you prefer to call) for overfunding their Roth. And the tracking on this would be very easy.

    Anyway, there seems to be enough confusion/disagreement over this that perhaps it wouldn’t work… Another consideration: this would be most beneficial when you’re young, but that’s when you can (probably) least afford to take advantage of it.

    But if someone came to me and offered me tax-free growth in return for (say) a 10% one-time surcharge, I’d probably do it. Would you? That was the real question here. Is, how high above 10% would you go? If not, how low would it have to be to pique your interest?

  5. Anonymous

    Kevin said “One curious item about Roth, is the gains are essentially tax free, where in the tax-deferred traditional, all money is taxed when it’s withdrawn”

    You are correct about traditional IRA/401k withdrawals being subjected to income taxes, but that money is also subjected to the personal exemptions, standard deductions, and low marginal tax brackets (10%, 15%, etc) allowing it to be taxed at a far lower effective tax rate in retirement (compared to your highest marginal rate in a Roth today).

  6. Anonymous

    But, why, right? The incentive to do this is for the government to maximize revenue – so an annual fee probably doesn’t do that. However, a recurring fee that doesn’t kill your return might just do that.

    Just my two cents.

  7. Just to be clear, I’m not talking about an annual fee here. It would be a one-time thing. You’d pay a fee to put in extra money in that year and then it would grow for as long as you want and then come out completely tax free.

  8. Anonymous

    Per Nickels actual question (verses everything else we’re commented on ;-P ) — No, I’d not go over the surcharge. Economically, if just before a bull market, it would make economic sense to pay %6 surcharge if you are going to make %7 or more ROI. But one would have to be more of a betting man than myself. I guess after a series of market plunges, when it could drop even more, but the possible of 20% on the rebound would justify the penalty. I guess I’m too “legalistic,” in desiring to play with in the rules, than see a small punitive action as an opportunity.

  9. Anonymous

    One curious item about Roth, is the gains are essentially tax free, where in the tax-deferred traditional, all money is taxed when it’s withdrawn.

    That said, I am using a blend of Traditional and Roth. Each do have their advantages in different areas, more than the just when it’s taxed, to willing it to charity, to other side items. My situation is made more complex because I have inherited IRAs. The Roth was easy for it was over five years old, the tax-deferred have Required Minimum Distributions [Value on 12/31 divided by (result of US average life expectancy minus your age at end of year) — ex. $100K at years end for a 40 year old — $100K/(83.6-40)=$2,293.58 — thus they grow the closer one is 83.6 years old]. That’s a whole other topic in itself, but by my spreadsheet, the future the RMDs could kick me into a higher tax bracket, so my plan is to more from Roth to Traditional (I’ve chosen a sliding scale) as those RMD get larger.

    My point, is there is no one-size-fits-all solution. There are some huge advantages to Roths, but if you’re a few thousand above kicking yourself into a lower tax bracket, the Tradition could be better. You may be in a field where the average compensation will take you above the Roth income limits, in which case maxing out Roth contributions now might make the more sense. Under current law, Roths give you have better access to your contributions before 59.5, if you fear you might hit your retirement fund for true life crisis. In my case started $5K Roth, then 4 to 1, planning to slide to $5 Traditional (obviously, not reflecting the changes to the law for inflation adjustment, but same logic).

  10. Anonymous

    The option to deposit to the Traditional IRA, but not deduct it, and soon after, convert, has been around for some time now.
    This has been called the “back door Roth IRA.” This comes with the need to prorate any existing pre-tax money one has across their traditional IRA accounts. i.e. pay tax on conversions in proportion to the pretax money in their accounts.
    In effect, this satisfies much of the ‘buy your way in’ suggestion. For those who have a very large pre tax IRA balance, the ‘advanced version’ suggests moving the pretax dollars into a 401(k). Any side income can qualify one for the individual 401(k) to provide that shelter and split off the post tax deposits.

  11. Anonymous

    The National Seniors Council is a scare group created by some conservative fringe folks – and is probably funded by the Koch brothers. They’ve been fact checked by numerous groups, but my favorite is the Annenberg Foundation’s work on the matter:

    I encourage you to read, and please come back to the real world. I’ll repeat what I said before: there is no serious discussion regarding nationalizing IRAs and 401Ks.

  12. Anonymous

    Frank, this talk of nationalizing pensions has been around for years. Look at the National Seniors Council article published 10/13/10. From the article: “Deputy Treasury Secretary J. Mark Iwry, who presided over the hearing, is a long-time critic of 401k plans because he believes they benefit the rich. He also appears to be one of the Administration’s point man on this issue.”
    I take it you swallow whatever the state and federal gvt proclaims as if it were from on high. I have learned not to trust the government as they constantly change the laws to torpedo my plans.

  13. Anonymous

    It’s an interesting thought experiment. Who do Roth IRAs appeal to?

    1. The young who expect their incomes to rise throughout their careers, and therefore expect to have a large amount saved up. Especially considering the burden of the federal debt will keep taxes high well into the future for the lifetime of people in their 20s and 30s.
    2. Those medium to high net worth individuals that put a premium on their retirement lifestyles and therefore use Roth IRAs as a tax hedge.

    So, given that the income you receive from a Roth is tax free – and compounds years to year – while the penalty you pay is only on the principal (if I’m not mistaken), then you would want to make the penalty lower than the nominal return rate (after taxes) people would otherwise experience. Since most people aim for 6-8% nominal returns after fees, a 6% penalty on the principal basically gives the return and doesn’t allow for the benefits of compounding either. So, if one was to return 6% nominally each year, then they would also pay that interest back year year. So, the investor would actually be losing money in real terms.

    So, perhaps the base penalty rate would be in fact be one that is equal to CPI (or chained CPI) – basically it means you couldn’t use Roth IRA as a savings account because you would lose – in real terms – lose 2-3% a year. Some measure of CPI is probably the place that would maximize revenue for the government.

    Just my two cents.

  14. Anonymous

    That’s an interesting thought… might help revenue now but would definitely hurt revenue later. We’d have to cut costs in the future before that is effective.

  15. Anonymous

    The governments change the laws on down the road when it is to their advantage. There is serious talk of nationalizing our IRAs and 401ks to make it fairer to those Thad didn’t have the means to contribute. I have seen changes to my state’s public employeeirement retirement plan and the DoD is changing the military health care 1oct. By kicking retirees out of tricare prime. Hide and watch. I made my last Roth contribution last year and am pondering crashing out before age 59 1/2 and taking the penalty. Monster boxes of silver would have been a far better investment since 1986.

  16. Anonymous

    Heh, where I am currently in my marginal bracket, you couldn’t pay me to use a Roth, much less would I be willing to pay a premium for “extra-Roth” — I’m 100% traditional.

  17. That’s what I’m suggesting. A one-time % fee, not an ongoing penalty like they have right now.

    If you were offered an opportunity to over-fund your Roth for a 10% surcharge, would you do it?

  18. Anonymous

    To me this seems to defeat the purpose. I would use a Roth if I felt that my tax bill today is lower than the tax bill in the future. If you increase the tax bill today then that just makes a Roth less appealing versus traditional IRA.

    But if they were to implement such an idea I’d say it could work if they just did a one time only 10% penalty tax when you put it in. I would not tax the amount of the money every year as that would add up too much over the years.

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