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The worst budget gimmick in the fiscal cliff deal

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Buried in the fiscal cliff deal is a small provision with big political significance: The bill makes it much easier for ordinary Americans to convert traditional 401(k) retirement accounts into Roth accounts, which the Congressional Budget Office has scored to raise $12 billion over 10 years.

The White House and congressional Democrats insisted on including the revenue-raiser to offset half of the sequester's two-month delay. The other half of the sequester is offset by discretionary spending cuts. It's not that much money, relatively speaking, but the idea was to establish the principle of a 1:1 ratio of spending cuts to revenue for deficit reduction—an idea strongly opposed by Republicans, who've demanded as much as a 10:1 spending cuts to revenue ratio.

The only problem is that it's highly unlikely to raise that much revenue in the long term—in fact, it's at best likely to break even and at worst be a big revenue loser, tax experts say.

The reason lies in the fundamental structure of Roth retirement accounts. In a traditional 401(k), your retirement savings aren't taxed until they're withdrawn years later. When you put retirement savings into a Roth account, however, your contributions are taxed immediately upfront and aren't taxed again when they're withdrawn, however much they've grown over time. That means that the government gets the tax revenue right away, rather than years later.

Under the fiscal cliff deal, it will be much easier for people to move their existing retirement savings into Roth accounts. Previously, you needed to reach 59 1/2 years of age or leave your employer to convert your traditional 401(k) to a Roth. The fiscal cliff deal lifts those restrictions, and the CBO anticipates that enough people will take advantage of the new rules to raise $12 billion in the next 10 years.

The opportunity will be particularly appealing to wealthy savers, who can afford to pay the taxes upfront and can use the Roth to increase the future value of their retirement accounts, says Kaye Thamas, a tax expert and founder of Fairmark Press. It could also appeal to some lower-income earners who anticipate being taxed at higher rates in the future and want to tax advantage of their low tax rate now.

But the change means that the government could lose out on long-term revenue, as it won't get revenue from the bigger pot of savings that's grown over time or from future tax increases on those saving for retirement. In fact, that's the entire reason for signing up for a Roth account in the first place: to avoid paying more taxes on your retirement savings down the road, when they've grown bigger and tax rates could be higher. "No one would chose a Roth without having thought they intended it to be something that saves them money in the long run," says Thomas. "They raise revenue in the short term and over the long term they may be neutral or may be actual revenue loser…From that perspective this is a budget gimmick."

That said, it's still counts as $12 billion in revenue to the CBO, because the office—and most legislators—uses a 10-year window to evaluate legislation. But in reality, it's a "way to game revenue in the window," says Joe Rosenberg, a research associate at the Tax Policy Center. "If you looked at the long horizon, you could lose money in future…the government would probably at best break even."