Rich’s tax strategy, Roth backdoor survives in latest Democratic plan
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A wealthy-favored retirement tax strategy has survived in the Democrats’ latest social and climate spending plan, after an earlier version put it on the chopping block.
Roth backdoor strategies are a way for the wealthy to bypass the income and savings limits that apply to Roth individual retirement accounts.
In its simplest form, the strategy involves an investor putting money into an account other than Roth and then converting it to a Roth IRA.
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Roth IRAs offer two great advantages to the wealthy: neither investment growth nor account withdrawals are taxable if funds are withdrawn after age 59 and a half, and there are no minimum distributions required at from age 72, as is the case with traditional retirement accounts.
“The reason the rich do this is that they don’t want to pay taxes on their investments,” said Albert Feuer, a tax and benefits lawyer in Forest Hills, New York. “The fact that they don’t have RMD rules supercharges [the accounts] Even further. “
The House Ways and Means Committee proposed closing the loopholes as part of a broad package of reforms aimed at making the tax code fairer and raising money for the Democrats’ social and climate agenda (which was then considered up to $ 3.5 trillion). The Committee adopted the measures in September.
However, a $ 1.75 trillion Build Back Better framework released Thursday by the White House – the result of months of negotiations between moderate and progressive lawmakers – would keep the loopholes intact.
The new vision for tax reforms also omits many other retirement measures included in the House package, such as the new RMD rules for accounts over $ 10 million.
However, negotiations are ongoing and retirement rules may reappear – especially if Democrats add measures that raise the total price of legislation and must find new sources of funding.
These can include, for example, changes to the current limit of $ 10,000 on a federal tax deduction for state and local taxes.
“Until we have a law, we cannot be sure what it will contain,” Feuer warned.
Current law prohibits any contribution to Roth accounts for single taxpayers with annual income exceeding $ 140,000. (The limit is $ 208,000 for married couples filing a joint tax return.)
However, the law allows high earners to convert funds from a pre-tax IRA – which has no income limit – into a Roth IRA. (They must pay taxes on the converted funds.) These pre-tax IRAs may hold a substantial amount of money from a 401 (k) plan whose funds have been renewed.
(Although there is no income limit for pre-tax IRA contributions, high incomes cannot claim a tax deduction for those contributions above a certain income. The threshold varies depending on whether the person has or not a workplace pension plan.)
The House tax proposal would have prohibited conversions of IRA and 401 (k) funds to a Roth account. It would have applied in 2032, for single taxpayers with taxable income greater than $ 400,000 or married taxpayers filing jointly with income greater than $ 450,000.
Roth Mega Backdoor
Current law also allows for a “Roth mega backdoor” strategy to get even more money into a Roth IRA.
IRAs have an annual contribution limit of $ 6,000. (People over 50 can save $ 1,000 more per year.)
But 401 (k) and other artboards have much higher limits. In some cases, workers can save up to $ 58,000 per year (or $ 64,500 for those over 50) by contributing “after tax”.
Unlike Roth accounts, the growth of investment in this after-tax savings is taxable. However, wealthy investors typically avoid tax by quickly converting that after-tax money into a Roth IRA – the so-called mega backdoor strategy.
The House tax proposal would have banned all after-tax employee contributions and prohibited the conversion of after-tax contributions to a Roth account. The measure would have applied to all income levels from 2022.
(According to the Plan Sponsor Council of America, 1 in 5 401 (k) plans currently allow these after-tax contributions.)