The House Democrats proposed several changes to retirement plans on September 13, 2021. This is part of their wider plan to make the tax code more equitable and pay for the $3.5 trillion budget plan under consideration. The proposed plan will lead to several changes to IRA and 401(k) retirement accounts. In particular, this will spell the end of the backdoor Roth and mega backdoor Roth strategies. If this bill is approved, most of these changes will begin in 2022.
This blog will cover the three main changes to retirement plans that the bill is proposing. The first two changes will likely only affect a small fraction of the population, whereas the third change may actually affect you.
3 Proposed Changes to IRAs and 401(k) Plans
1. New Contribution Limit:
This bill will prohibit taxpayers from contributing to a Roth or a Traditional IRA once their total retirement account balance exceeds $10 million. This total is counted as the sum of one’s IRA and 401(k)-type workplace accounts. The contribution limit would apply to single taxpayers with more than $400,000 of taxable income, $425,000 for head of households, and $450,000 for married filing jointly taxpayers. There is a slight disadvantage for married filing jointly taxpayers. If you were two single taxpayers making $400,000 each you could still contribute, but not if both filed married filing jointly.
2. New Required Minimum Distribution:
Individuals whose combined IRA and 401(k) retirement accounts exceeding $10 million at year’s end would have to withdraw at least 50% of the excess the following year. Those with accounts over $20 million will have to withdraw from Roth IRAs and 401(k)s first. This would only apply to those with incomes over the same limits as above – more than $400,000 of taxable income, $425,000 for head of households, and $450,000 for married filing jointly taxpayers.
3. Eliminates “Backdoor” Roth IRA Strategy:
The new retirement plan proposal would affect two types of backdoor Roth strategies. This includes the basic backdoor Roth IRA and the mega backdoor Roth IRA. It will end up eliminating these strategies.
- Basic Backdoor Roth IRA
Under the current law, you can get around the Roth IRA income limits by doing the backdoor Roth IRA strategy. A backdoor Roth IRA is when you contribute to an after-tax traditional IRA, and then convert it to a Roth IRA. Since anyone can contribute to a Traditional IRA, this allows you to go around the Roth income limits. You pay the taxes you owe on that money right away. But the investments then grow tax-free.
This bill would prohibit the conversion of an after-tax IRA to a Roth IRA, thus totally eliminating the backdoor Roth IRA strategy
- Mega Backdoor Roth IRA
The mega backdoor Roth IRA uses a similar strategy to the backdoor Roth IRA. It is a retirement savings strategy that can allow you to put up to $38,500 in after-tax 401(k) contributions, then convert that to a Roth 401(k), and eventually to a Roth IRA. This $38,500 is on top of your regular $19,500 annual contribution and can only be found in very few 401(k) plans. If available, this currently lets savers contribute up to $58,000 total in a 401(k).
The proposed plan would prohibit all employee after-tax contributions in 401(k)s. In doing so, the bill would completely eliminate the mega backdoor Roth strategy. This policy will apply to everyone regardless of their income level.
This would come into effect starting January 1, 2022.
The House Ways and Means Committee will vote on these proposed changes to retirement plans this week. We will keep you updated with these changes.
Alvin Carlos, CFP®, CFA is an investment advisor and fee-only financial planner, in Washington, D.C that works with clients across the country. He has a Master’s degree in International Relations from SAIS-Johns Hopkins. Alvin is a partner of District Capital, a financial planning firm designed to help 30s and 40s professionals achieve their financial goals through smart investing, reducing taxes, retirement planning, and maximizing their money. Schedule a free discovery call to learn how we can help elevate your finances.