Days appear to be numbered for backdoor Roth and mega-backdoor Roth IRA conversion strategies increasingly used in recent years by wealthy retirement savers.
As part of its markup of President Joe Biden’s $3.5 trillion spending package, on Sept. 15 the House Ways and Means Committee approved legislation from House Democrats that would prohibit use of the mega-backdoor Roth conversion starting Jan. 1, 2022 as a way to help pay for the massive spending in the proposed social safety net and climate change bill, along with other proposed tax hikes on the wealthy and corporations.
The House Budget Committee voted 20-17 Saturday to pass the $3.5 trillion social safety net and climate change spending bill out of committee and send it to the House floor, where it can still be amended. While Democratic leaders admit the bill will need to be trimmed down in order to pass (likely with a simple majority without GOP support), this particular provision figures to stick as one of the key “pay-fors.”
Proposals relating to Roth conversions would raise an estimated $749 billion over a decade to help pay for the bill
No less of an IRA authority than Ed Slott says he expects the prohibition on mega-backdoor Roth conversions to remain in the bill. Slott told The Wall Street Journal he expects the provision to “sail right through,” and advised interested parties to “do it while you can.”
The proposals relating to Roth conversions would raise an estimated $749 billion over the first decade to help pay for the bill, according to the nonpartisan Congressional Joint Committee on Taxation.
All told, the proposals make significant changes to the estate planning landscape for all high-net-worth individuals, including the potential termination of multiple estate planning methods that advisors have traditionally recommended.
What’s at stake
The provisions relating to Roth conversions generally limit high-earners from making IRA contributions, requires them to disgorge excess amounts, and prohibits IRAs from utilizing certain investments that have the potential to generate particularly high rates of return (such as private equity) but aren’t available to most people.
It would also prohibit an IRA to be invested in any investment where the IRA owner owns 10% or more of the entity (currently this is 50% or more) or where the IRA owner is an officer or director.
Critics warn that the changes are overly broad and would have a negative impact many non-HNW investors, potentially harming the funding of small businesses.
In a Sept. 24 brief, Katten Muchin Rosenman LLP addressed some specifics of the retirement provisions. Per that brief:
If enacted, all taxpayers, regardless of income, would not be able to convert any after-tax contributions made to qualified retirement plans or IRAs to a Roth account or Roth IRA, effective for tax years beginning January 1, 2022.
There also are proposed significant changes for large retirement accounts. Beginning in 2022, regardless of a taxpayer’s age, taxpayers earning more than $400,000 (or $450,000 for joint filers) with a combined traditional IRA, Roth IRA and defined contribution retirement account balance exceeding $10 million would be required to withdraw 50% of the balance over $10 million.
For any aggregate traditional IRA, Roth IRA and defined contribution retirement plan balance over $20 million, 100% of the excess over $20 million must be withdrawn from Roth accounts up to the lesser of (1) the amount needed to bring the total balance of such accounts below $20 million and (2) the aggregate balance of the taxpayer’s Roth accounts.
The taxpayer will also have to pay income tax on such withdrawn amounts on an annual basis. Additionally, for high-income taxpayers, the new provisions would prohibit any additional contributions to traditional and Roth IRAs if the aggregate balance of a taxpayer’s retirement accounts exceeds $10 million.
The proposal also contains limitations on conversions of traditional IRA money based on pretax contributions starting in 2032 for those earning $400,000 or more (or $450,000 for joint filers), completely eliminating the ability of this subset to do a Roth conversion after this date.
Why now
Ever since ProPublica reported in June that PayPal co-founder Peter Thiel owns a Roth IRA that had grown from less than $2,000 in 1999 to a staggering $5 billion in 2019, lawmakers have placed increased scrutiny on how some ultra-wealthy individuals have amassed huge fortunes in the tax-sheltered individual retirement accounts intended to provide retirement security to middle-class families.
Most 401k plans don’t allow mega-backdoor Roth conversions, but a growing number (especially technology companies with high-earning employees) have added the feature in recent years to help them compete for elite talent.
The Sept. 24 WSJ article cites Alight Solutions research showing that about 30% of plan sponsors allow the mega-backdoor strategy in their 401ks, and nearly 20% of the 23,500 401k plans administered by Fidelity Investments allow it.
Senate Finance Committee Chair Ron Wyden, (D-OR) and House Ways & Means Committee Chair Richard E. Neal, (D-MA) released new data on July 28 requested from the Joint Committee on Taxation (JCT) on the prevalence of “mega-IRA” accounts.
The new JCT data show a threefold increase in aggregate IRA account balances of $5 million of more between 2014 and 2019. As of the 2019 tax year, more than 28,000 taxpayers had aggregate IRA account balances of $5 million or more, and 497 taxpayers have aggregate IRA account balances of $25 million or more. The average aggregate account balance for these 497 taxpayers was more than $150 million.
SEE ALSO:
• ‘Explosion’ in Use of Mega-IRAs by Wealthy Revealed in New Data Released by Wyden, Neal
• The Stretch IRA Went Away With The SECURE Act—Here Are Other Options