The Rich Get Richer

The time period of the economic meltdown and its ongoing aftermath have the potential to move even more money upstream to the wealthiest Americans than happened in the previous decade. As part of the Bush tax bills, high-income earners have the limited opportunity this year and next to roll their traditional IRAs into Roth IRAs. This move is for long-term wealthy who do not anticipate needing the money for a long time, if ever.

--In a traditional IRA, you deposit money before tax, the money grows without tax, but you pay tax on the entire balance as you withdraw it in retirement. The assumption is that your tax bracket will be lower after retirement, so you will pay less overall. After age 70, you must start withdrawing an amount based on a formula determined by your age and your total balance.

--In a Roth IRA, you deposit after-tax money and never pay tax again. There is no minimum withdrawal ever. Until this year, contribution to a Roth IRA was limited by income. The modified adjusted growth income (MAGI) limits for 2009 were $105,000 - $120,000 for those filing single and $166,000-$176,000 for those filing married.

Contributions to IRAs are limited, but other nonqualified accounts can be rolled into IRAs and then into Roth IRAs, which can increase the total substantially.

If you elect to convert, you pay tax on the balance at the time of conversion (over a 2-yr period), no tax on further growth, and no tax on withdrawal. Thus, you want to convert when the market looks bad (say, June 30). Once you convert, that money is essentially taken out of the taxable stream. No one will ever pay tax on its earnings.

The government has known for years that this conversion window would be a boon to revenue--all those rich people paying taxes on retirement balances at the same time. But by doing this, it is also frontloading tax revenue--taking some revenue now instead of more over time later.

The big factor determining whether a person ought to convert is how soon he will need the money. Obviously it doesn't make sense for someone to pay a big tiered tax bill now if he had been planning to start withdrawals soon at a lower rate. But if he has many years of earnings ahead--and doesn't want to be forced to take withdrawals at age 70--converting makes a lot of sense.

Adding to the incentive to convert, the rich currently enjoy low tax rates--rates that will rise. It may be better to pay a lump sum tax at known rates now than incremental tax in some unknown future at a rate that might be higher even after retirement.

Add to that:

--The rich have the opportunity to add to their wealth now by acquisition of assets--real estate and business--at depressed prices.

--The millions of unemployed and underemployed are draining their own wealth. And all that money withdrawn from qualified retirement savings before retirement generates penalty income to the government.

--The longer the recovery is dragged out, the more people will be sucked under--and their assets delivered up to the wealthy.

And it's clear we still have a long way to go to stop the gravy train for the rich, let alone reverse it.