Congressional Democrats want to slam shut a tax loophole known as the Roth IRA “backdoor.” In one of several proposed changes targeting the retirement accounts of wealthy Americans, Democrats on the House Ways and Means Committee want to bar people making more than $400,000 a year from pre-tax retirement savings accounts converted into a Roth IRA. The proposed reforms are part of a Democratic push to raise taxes on the wealthiest to fund a $3.5 trillion spending plan.
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“Backdoor” Roth IRA Conversion – Definitive and Dismissal Recommendations
Under current tax law, individuals making more than $140,000 a year are prohibited from contributing to a Roth IRA, where retirement savings grow tax-free. Since 2010, however, workers who exceed this income threshold have been allowed to convert their pre-tax contributions into a Roth IRA. After paying income taxes on the initial contributions and gains, their retirement savings grow tax-free and will no longer be subject to required minimum distributions (RMDs).
These backdoor Roth conversions, which have grown in popularity, allow high-income earners to bypass the income requirements on Roth IRAs and capitalize on the tax-free growth these account types offer.
But the use of this strategy may be coming to an end. Democrats on the House Ways and Means proposal, want to ban Roth conversions for people making more than $400,000 a year. If approved, the rule change would apply to distributions, transfers and contributions made in taxable years beginning December 31, 2021.
The proposed legislation also seeks to eliminate “mega backdoor” Roths, a sophisticated strategy that allows people enrolled in certain retirement plans to save up to $38,500 in additional after-tax contributions for retirement. If approved, the provision targeting backdoor mega wheel conversions would take effect after December 31, 2021.
New Limits on IRA Contributions
Democrats also want to prevent high-income taxpayers from collecting tax-deferred money inside retirement accounts. To do so, they plan to restrict people above certain income thresholds from continuing to contribute to Roth and traditional IRAs if they already have $10 million saved in IRAs or other defined contribution retirement accounts . Under current law, taxpayers can contribute to IRAs regardless of how much they have already saved.
The proposed limit on contributions would apply to single or married taxpayers filing separately and making more than $400,000, married taxpayers filing jointly with taxable income of more than $450,000 and heads of households making more than $425,000.
The proposed crackdown comes as the retirement accounts of the wealthiest Americans continue to swell. According to the Government Accountability Office, 9,000 taxpayers had at least $5 million saved in IRAs in 2011. Eight years later, that number had tripled to more than 28,000, data from the Joint Committee on Taxation shows.
Under this part of the Democratic proposal, employer-sponsored defined contribution plans would have to report balances over $2.5 million to the Internal Revenue Service and the plan participant whose balance is over $2.5 million.
Minimum Distribution Required for Accounts Greater than $10 Million
Democrats also propose that high-income earners who have more than $10 million saved in retirement accounts must take minimum distributions from those accounts.
“If the individual’s combined traditional, Roth IRA and defined contribution retirement account balances exceed $10 million at the end of the taxable year, a minimum distribution would be required for the following year,” the proposal states.
Under the legislation, the IRS would require high-income earners with more than $10 million saved in retirement accounts to take a distribution equal to 50% of their savings that exceed the $10 million threshold. For example, if Joan has $12 million in her 401(k) and various IRAs, she would take a $1 million distribution the following year.
The income thresholds would be identical to those from the proposal that aims to reduce IRA contributions for the wealthy. If approved, both provisions would take effect after December 31, 2021.
Big changes could be coming to the retirement accounts of wealthy Americans. Democrats on the House Ways and Means Committee want to end backdoor Roth IRA conversions, bar high-income earners with more than $10 million in retirement accounts from contributing to their IRAs and mandate that certain high-income earners take savings huge retirement annual distributions.
Retirement Planning Tips
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