They Just Started Taxing Your Roth IRA

While everyone has been distracted by the drama coming out of Washington a new tax was instituted that affects Roth IRAs. The change is so significant that many people will need to change their retirement plans if they wish to meet their retirement goals.

Because this has been such an underhanded and sneaky tax increase on retirees and retirement planning it takes a bit to show how they will collect the tax from you. And there is no way to avoid the new tax on Roth IRAs, including the Roth portion at your work 401(k).

Let me start by showing you the basics on how Roth IRAs work over traditional retirement plans.

Tax on Roth IRAs

As you likely know, Roth IRAs avoid income tax on distributions but get no deduction for contributions.

This is actually a trade-off compared to traditions IRAs (tIRA), 401(k), and other traditional retirement plan options. Traditional retirement plan options offer a deduction, with some limits, for contributions, grow tax-deferred, and are taxed at ordinary income tax rates when distributions are taken.

Roth retirement plans flip the income taxes around. Because there is no deduction for Roth contributions there is no tax benefit up front. Instead, all the gains are not taxed as realized or upon distribution. The earlier you start, the larger your Roth IRA usually becomes and that means more income in retirement without paying income taxes. Roth retirement plan distributions also hold the possibility of keeping your federal income taxes on Social Security benefits lower, along with other taxes assessed at higher income levels.

Until now.

Why The Government Had to Eventually Tax Roth Retirement Plans

Roth IRAs were a great way to encourage people to invest for their retirement. It was also a great way to raise more tax revenue early on for the government due to Roth contributions not getting an income tax deduction.

Then time passed and the value of all Roth IRAs started to get huge. People taking distributions were not paying any income taxes on this money. No longer were Roth contributions feeding more money to the U.S. Treasury.

With the federal government’s debt over $36 trillion and the 2025 estimated annual deficit over 6% of GDP, lost tax revenues have to come from somewhere.

For perspective, there was $17 trillion (that is trillion with a “t”) in all IRAs at the end of 2024, according to Kiplinger. The IRS does not break out how much money is in traditional versus Roth IRAs. What we do know is that 26% of IRAs are Roth, according to the Investment Company Institute.

Armed with these data points we can make a reasonable estimate on how much money is in Roth retirement plans and how much tax revenue the federal government will lose.

Making the broad assumption Roth IRA and tIRAs have the same average value we simply take $17 trillion and multiply by 26%, giving us a combined estimated Roth IRA value of $4.42 trillion. And this does NOT include any Roth retirement plan values in 401(k) plans! (UPDATE! The Investment Company Institute contacted me when they noticed I linked to them and their data. They corrected my numbers with actual number. According to the ICI, “Roth IRAs make up 12% of total IRA assets amounting to about $2 trillion.” A thank you is owed to Myiah Gatling at the ICI for catching my error and providing me with accurate information. Thank you.)

Taking the $4.42 trillion and applying a 25% income tax rate across all Roth IRAs on average means the U.S. federal government will miss out on over $1 trillion in tax revenue. (Armed with the updated data the federal government stands to lose out ~$500 billion in tax revenue when current Roth IRA balances are distributed.)

Time to Tax Roth IRAs

With more than $1 trillion in tax revenue lost (and the number continuing to climb) the government had to do something.

When the Roth IRA first came out in 1997 I was more than a decade into my tax accounting career. At the time I did some back-of-the-envelope calculations estimating accumulated Roth account values into the future. It did not take long to see that a couple generations (a generation is defined as 40 years) of Roth IRAs would become a big problem as most income would avoid tax 100 years out. Wealth would accumulate like never before. Of course, not all income would come from Roth products.

We are not even one generation from the Roth inception and we can see a growing portion of the wealth pie going to Roth IRAs. And since it grows without tax it can grow much faster than other investments. Couple that with no required minimum distributions and it is easy to see how Roth IRAs would become an issue for the government.

Back in 1997 I felt that at some point Roth IRAs would end up taxed. I thought it would be income tax because that is what retirement plans affect (tax deduction in or no tax on distribution; pick your poison).

I never thought the government would do much, much worse.

The Achille’s Heel of Roth IRAs is the promise from the government that forgoing an up front income tax deduction would be more than offset by future distribution not subject to income tax.

I thought the worst that could happen was that Roth distributions would be needs tested at some point. In other words, Roth distributions would avoid tax if your income was under a certain income level only. But that is not what is happening.

Instead, the current administration has said they want to replace some or all of the income tax with tariffs. And as we have discussed in these pages before, tariffs are a tax, and a regressive tax at that. Someone has to pay the tariff along the way. That cost is passed along to the end consumer, the one who really pays the tax.

Therefore, you forwent an income tax deduction when you contributed to your Roth IRA and now when you retire and spend the money you will pay tax again on that contribution in the form of a tariff tax. At least the gains are only taxed once.

Retirement Planning In the New World Order

Over the decades I encouraged consulting clients to take a middle-of-the-road approach to retirement plan contributions. Some goes into Roth products and some into traditional where you get a current income tax deduction. My argument was that you never know with 100% clarity if the Roth or traditional will be a better deal so splitting the bet made the most sense. In the end, under the old tax system, the Roth and tIRA were exactly the same if all parameters were equal. That is no longer the case.

The only way to avoid the tariff tax is to not spend. Imports will have the tariff tax built in and domestic producers can raise their prices due to less competitive competitors. Consumers lose under this system every time.

Now we have to rethink our retirement planning strategy. Prior planning is water under the bridge. Going forward we need to pull out our crystal ball yet again and make a judgement call. My personal opinion is that tariffs will eventually slow the economy (as all taxes tend to do). The government will feel the pain of a recession and lower the tariffs. In my opinion! I could be wrong. Hard to believe, but it is true.

If your crystal ball says tariffs will stay and replace some or all of the income tax, your retirement planning needs some adjustments. Roth contributions do not get an income tax deduction. If income tax rates continue lower, or even zero, then you want to capture tax deductions while you can (a bird in the hand is worth two in the bush) because you will pay the tariff tax later. That means traditional IRA and 401(k) contributions are superior to the Roth in a tariff tax world.

With tariffs about to support more of the tax collections for the federal government, income tax deductions now are worth more. If the income tax is completely replaced by tariffs (unlikely in IMHO) the Roth acts a lot more like a non-deductible traditional IRA. Think about it for a moment and you will see what I mean.

And if all this was not enough bad news, I have one last kick to the knees.

Income taxes have a lot of tax planning opportunities. Income taxes are considered a voluntary tax, meaning you submit your tax returns with the required data. It also means you can volunteer to use tax strategies to reduce your tax liability.

Tariffs are an involuntary tax. Like payroll taxes and sales taxes, tariffs are collected and paid to the government before individual taxpayers have a chance to lower the tax with legal strategies. Reporting, and payment, to the government is done for you, hence involuntary.

Tariffs are a flat tax that hits the middle class and the poor more than the wealthy. Whereas the payroll tax (Social Security and Medicare withholding from wages) is a flat tax removed before you get your paycheck and sales taxes are collected by the retailer, tariffs are collected at the docks when products are imported. The tariff is included in the wholesale price the retailer pays and that cost is passed along to you. And if you paid income tax on that Roth contribution and the tariff tax when you get your money back and spend it, you have been double taxed on your money. Plan accordingly.