“Mega” Roth and “Backdoor Roth” IRAs may well be eliminated under the roughly $2 trillion social and climate spending bill passed by the House of Representatives on Friday morning—something that will happen if the Senate passes the bill on to President Biden with the Roth provisions intact. But actual elimination may not happen for several years unless effective dates for some provisions are changed by the Senate.
House Democrats passed the massive spending bill (H.R. 5376) along party lines, 220-213. It is being called one of the most consequential pieces of legislation in half a century and is the centerpiece of President Joe Biden’s “Build Back Better” domestic agenda.
It now heads to the Senate, where it is likely to be amended and faces an uncertain future in a chamber with a 50-50 split between Democrats and Republicans. Democratic Senators Joe Manchin of West Virginia and Kyrsten Sinema of Arizona continue to be the wild cards, along with Independent Bernie Sanders, who has already said he hopes to see the bill “strengthened in a number of ways” in the Senate, including renewed calls for the wealthy “to pay their fair share of taxes” (something Sinema opposes).
The bill is moving through Congress under the reconciliation process that shields it from a filibuster, allowing Democrats to push it through over unified Republican opposition in the Senate.
Of keen interest to the retirement industry are a series of provisions in the House’s version of the bill that would prohibit wealthy Americans from using some popular strategies to move money into Roth IRAs. These provisions—added back into the bill as federal government revenue-generating “pay-fors” to help offset the spending—have largely flown under the radar during debates where the state and local tax deduction (SALT) cap, disputes over revenue generated by bulked-up IRS enforcement and Congressional Budget Office scores have dominated the headlines.
The bill’s retirement provisions are estimated by the CBO and the Joint Committee on Taxation to raise approximately $10 billion (of the $1.5 trillion the CBO says all the bill’s “pay-fors” would raise) from 2022-2031—a significantly lower total than it could potentially be because some of the retirement provisions would not take effect until 2029 and 2031 instead of 2022.
The provisions are outlined in the most recent summary of the bill, in a section titled, “PART 3—Modifications of Rules Relating to Retirement Plans.”
There you will find, along with effective dates:
• Section 138301: Contribution Limit for Individual Retirement Plans of High-Income Taxpayers with Large Account Balances
The gist: Specifically, the legislation prohibits further contributions to a Roth or traditional IRA for a taxable year if the contributions would cause the total value of an individual’s IRA and defined contribution retirement accounts as of the end of the prior taxable year to exceed or further exceed $10 million. The limit on contributions would only apply to single taxpayers (or taxpayers married filing separately) with income over $400,000, married taxpayers filing jointly with income over $450,000, and heads of households with income over $425,000 (all indexed for inflation). The legislation also adds a new annual reporting requirement for employer defined contribution plans on aggregate account balances of at least $2.5 million. The reporting would be to both the Internal Revenue Service and the plan participant whose balance is being reported.
Effective date: tax years beginning after December 31, 2028.
• Section 138302: Increase in Minimum Required Distributions for High-Income Taxpayers with Large Retirement Account Balances
The gist: If an individual’s combined traditional IRA, Roth IRA and defined contribution retirement account balances generally exceed $10 million at the end of a taxable year, a minimum distribution would be required for the following year. This minimum distribution is only required if the taxpayer’s income is above the thresholds described in the section above (e.g., $450,000 for a joint return). The minimum distribution generally is 50% of the amount by which the individual’s prior year aggregate traditional IRA, Roth IRA and defined contribution account balance exceeds the $10 million limit, reduced by the amount described in the next paragraph.
In addition, to the extent that the combined balance amount in traditional IRAs, Roth IRAs and defined contribution plans exceeds $20 million, that excess is required to be distributed from Roth IRAs and Roth designated accounts in defined contribution plans up to the lesser of (1) the amount needed to bring the total balance in all accounts down to $20 million or (2) the aggregate balance in the Roth IRAs and designated Roth accounts in defined contribution plans. Once the individual distributes the amount of any excess required under this 100% distribution rule, then the individual is allowed to determine the accounts from which to distribute to satisfy the 50% distribution rule above, except that generally no amounts may be allocated to stock in a private company ESOP.
Effective date: tax years beginning after December 31, 2028.
• Section 138311: Tax Treatment of Rollovers to Roth IRAs and Accounts
The gist: Under current law, contributions to Roth IRAs have income limitations. Single taxpayers with income above $140,000 generally are not permitted to make Roth IRA contributions. However, in 2010, the similar income limitations for Roth IRA conversions were repealed, which allowed anyone to contribute to a Roth IRA through a conversion irrespective of the still in-force income limitations for Roth IRA contributions. As an example, if a person exceeds the income limitation for contributions to a Roth IRA, he or she can make a nondeductible contribution to a traditional IRA—and then shortly thereafter convert the nondeductible contribution from the traditional IRA to a Roth IRA.
In order to close this so-called “backdoor” Roth IRA strategy, and a similar one for retirement plans, this section prohibits all employee after-tax contributions in qualified plans and after-tax IRA contributions from being converted to Roth regardless of income level, effective for distributions, transfers, and contributions made after December 31, 2021.
In addition, the bill eliminates Roth conversions for both IRAs and employer-sponsored plans for single taxpayers (or taxpayers married filing separately) with taxable income over $400,000, married taxpayers filing jointly with taxable income over $450,000, and heads of households with taxable income over $425,000 (all indexed for inflation). This provision applies to distributions, transfers, and contributions made in taxable years beginning after December 31, 2031.
Effective dates: for “backdoor” Roths, effective for distributions, transfers, and contributions made after December 31, 2021. For the second provision in this section, it applies to distributions, transfers, and contributions made in taxable years beginning after December 31, 2031.
• Section 138312: Statute of Limitations with Respect to IRA noncompliance
The gist: The bill expands the statute of limitations for IRA noncompliance related to valuation-related misreporting and prohibited transactions from 3 years to 6 years to help IRS pursue these violations that may have originated outside the current statute’s 3-year window.
Effective date: This provision applies to taxes to which the current 3-year period ends after December 31, 2021.
• Section 138313: IRA Owners Treated as Disqualified Persons for Purposes of Prohibited Transactions Rules
The gist: The bill clarifies that, for purposes of applying the prohibited transaction rules with respect to an IRA, the IRA owner (including an individual who inherits an IRA as beneficiary after the IRA owner’s death) is always a disqualified person.
Effective date: This section applies to transactions occurring after December 31, 2021.
SEE ALSO:
• Mega Roth IRA Ban Back in Biden Bill, But Not Until 2029
• Dems Poised to Slam Door on Mega-Backdoor Roth IRAs
• Colorado, New Mexico First to Partner on State-Run IRA Program
Veteran financial services industry journalist Brian Anderson joined 401(k) Specialist as Managing Editor in January 2019. He has led editorial content for a variety of well-known properties including Insurance Forums, Life Insurance Selling, National Underwriter Life & Health, and Senior Market Advisor. He has always maintained a focus on providing readers with timely, useful information intended to help them build their business.