In this episode of Adam Talks, IRA Financial’s Adam Bergman Esq. discusses provisions in the proposed tax bill and how they affect Roth accounts.

All the talk lately, especially in the retirement planning community, is the tax bill proposal. Not only does it include provisions on taxes, but retirement accounts as well. Here, Adam Bergman will focus on the proposed Roth rules, and how it affects retirement investors.

Proposed Roth Rules

Here, we will detail each of the provisions related to Roth savers. They include the cap, the elimination of Backdoor Roth accounts, and conversions.

The Dreaded Cap

One thing we knew for sure that was coming was a cap. Originally, talks were only about capping Roth IRAs. The rumors that we heard was a $5 million cap on assets held in the after-tax plans. However, the proposal includes a cap for all of individual’s retirement plans in the aggregate – not just Roth IRAs!

The only good news is that the cap was raised to $10 million. However, you must stay below that number when you add all of your retirement savings, not just the Roth account. Therefore if you have $3 million in your Roth IRA and $8 million in your 401(k) plan, you are over the cap!

It’s important to keep in mind that the cap only applies to those making $400,000 or more annually, or $450,000 if you are married filing jointly. If your income is above those thresholds, and you have over $10 million in retirement savings, you must take a distribution. It seems you will have two years to withdraw the excess funds, but we’re not sure yet how taxes and penalties will work on the withdrawal.

No More Backdoor Roth IRA

If you earn too much money, you are not allowed to directly contribute to a Roth IRA. Basically, the IRS is saying that you are a high earner and cannot contribute to an after-tax plan. Which means you cannot enjoy tax-free wealth during retirement. However, in 2010, the income restriction was removed for converting traditional funds to Roth. The government needed money, and thought conversion would generate plenty!

You were allowed to convert your pretax IRA funds to Roth. Taxes were due on the amount you converted. However, all income and gains generated in the Roth would be tax-free once you reached age 59 1/2 and any Roth IRA had been opened for at least five years.

One of the most unpopular proposed Roth rules, is the elimination of the Backdoor Roth IRA for those making more than $400,000 or $450,000 for married filing jointly.

Related: Can I still do a Backdoor Roth IRA in 2022?

Elimination of the Mega Backdoor Roth 401(k)

Another popular strategy that could be eliminated is the Mega Backdoor Roth 401(k). If the plan allows it, you may contribute after-tax funds to your 401(k) plan, and then immediately convert them to a Roth IRA. This allows someone to supersize his or her tax-free income during retirement.

For 2021, you may contribute up to $58,000, or $64,500 if you are at least age 50, to a 401(k) plan in after-tax funds. This contribution is neither pretax or Roth. There is no upfront tax deduction on your contributions, and, if the funds remain in the 401(k), there is no tax-free withdrawals.

However, you are allowed to convert the funds to a Roth IRA, and take advantage of that plan. When you reach age 59 1/2 and the it’s been five years since the conversion, all distributions are tax free. No more!

If the deal gets passed with this provision, no one will be allowed to take advantage of this strategy. There is no income thresholds. To be fair, this may not affect a lot of people. Most plans do not offer the ability to max out your contributions with after-tax funds. But, if you are self-employed and utilize the Solo 401(k), you need to be aware of this.

Roth Conversion Income Limits

If you are above the previously mentioned $400/450k income limits, you cannot convert pretax IRA funds to a Roth IRA. Like most of these rules, it doesn’t make sense from a revenue-generating standpoint. The more money you make, the higher your tax bracket. And, since you pay taxes on the amount you convert based on your tax bracket, the higher it is, the more the government would receive.

No matter the size of your IRA, which has no bearing on this rule, you may not be able to convert funds to a Roth. The government thinks that the rich are trying to abuse the system, which is absolutely not true!

In Sum

The proposed Roth rules are not getting a lot of airtime right now, but they need to be considered. The whole idea of this tax proposal is to pay for President Biden’s programs. These provisions will not generate revenue for the government. More people will put their money inside pretax, traditional plan, or look elsewhere.

Be sure to keep listening to Adam Talks, as our focus is on all the emerging details of the tax proposal. Adam will bring you any breaking updates concerning the bill. You can check us out on SoundCloud, YouTube, or right here on the IRA Financial blog!