Democrats want to end the lucrative retirement loophole

Democrats are proposing a series of tax reforms related to retirement accounts, including eliminating behind-the-scenes Roth IRA conversions for the wealthiest Americans.

Congressional Democrats want to squarely close a tax loophole known as the Roth IRA “backdoor.” In one of several proposed changes aimed at 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 converting pre-tax retirement savings accounts to Roth IRAs. The proposed reforms are part of a push by Democrats to raise taxes on the wealthiest to fund a $3.5 trillion spending plan.

A financial advisor can help you understand potential changes in Washington law and how they might affect you. Find a consultant now.

“Backdoor” Roth IRA Conversions – Definition and Elimination Proposals

Democrats are proposing a series of tax reforms related to retirement accounts, including eliminating behind-the-scenes Roth IRA conversions for the wealthiest Americans.

Democrats are proposing a series of tax reforms related to retirement accounts, including eliminating behind-the-scenes Roth IRA conversions for the wealthiest Americans.

Under current tax law, people earning more than $140,000 a year are prohibited from contributing to a Roth IRA, where retirement savings grow tax-free. However, since 2010, workers who exceed this income limit are allowed to convert their pre-tax contributions to a Roth IRA. After paying income taxes on initial contributions and earnings, 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 of Roth IRAs and take advantage of the tax-free growth these types of accounts 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 tax years beginning after 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 extra contributions after retirement. If passed, the provision targeting mega backdoor Roth conversions would take effect after December 31, 2021.

New Limits on IRA Contributions

Democrats also want to bar high-income taxpayers from accumulating wealth tax-deferred in retirement accounts. To do this, they plan to restrict people who exceed certain income limits from continuing to contribute to Roth and traditional IRAs if they have already saved $10 million 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 making more than $400,000, married taxpayers filing jointly 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 saved at least $5 million in IRAs in 2011. Eight years later, that number had more than tripled to more than 28,000, according to data from the Joint Committee on Taxation.

Under this part of the Democratic proposal, employer-sponsored defined contribution plans would also have to report balances above $2.5 million to both the Internal Revenue Service and the plan participant whose balance exceeds $2. .5 million dollars.

Minimum distribution required for accounts exceeding $10 million

Democrats are proposing a series of tax reforms related to retirement accounts, including eliminating behind-the-scenes Roth IRA conversions for the wealthiest Americans.

Democrats are proposing a series of tax reforms related to retirement accounts, including eliminating behind-the-scenes Roth IRA conversions for the wealthiest Americans.

Democrats also propose that high-income individuals with more than $10 million saved in retirement accounts must take minimum distributions from those accounts.

“If an individual’s combined traditional IRA, Roth IRA, and defined retirement account balances generally exceed $10 million at the end of a taxable year, a minimum distribution will be required for the following year,” the proposal states.

Under the legislation, the IRS would require high-income earners who have saved more than $10 million in retirement accounts to take a distribution equal to 50% of their savings in excess of the $10 million threshold. For example, if Joan has $12 million in her 401(k) and various IRAs, she will be required to take a distribution of $1 million next year.

The income limits would be identical to those in the proposal aimed at limiting IRA contributions for the wealthy. If approved, both provisions would take effect after December 31, 2021.

Conclusion

Big changes could be coming to the retirement accounts of wealthy Americans. Democrats on the House Ways and Means Committee want to eliminate backdoor Roth IRA conversions, bar high-income earners with retirement accounts of more than $10 million from contributing to their IRAs and require some high-income earners with huge retirement savings to take annual distributions .

Retirement Planning Tips

  • Will you have enough money to retire comfortably? SmartAsset’s free 401(k) calculator can help you determine if you’re on track to retire on time.

  • Thinking of rolling over a 401(k) or performing a Roth IRA conversion? A financial advisor can help. Finding a financial advisor doesn’t have to be difficult. SmartAsset’s free tool matches you with up to three financial advisors in your area, and you can interview your advisors at no cost to decide who is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.

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