Are Backdoor and Mega-Backdoor Roth IRA Conversions on the Chopping Block?
House Democrats have recently proposed new retirement plan rules for the wealthy, including contribution limits and a repeal of Roth conversions, according to this CNBC article. The House Ways and Means Committee revealed how it intends to help pay for the $3.5 trillion reconciliation “human infrastructure” bill. The legislation is very broad and will look to increase tax revenues through a combination of tax increases (individual and corporate), changes to deductible items, and an overhaul of retirement plans. If you currently have after-tax dollars sitting in an IRA or inside of an employer-sponsored retirement plan such as a 401K, then you should be following this closely.
Elimination of Roth Conversions
One standout for individuals and households is the possible elimination of Roth conversions for high-income folks (but not until 2031). But employees may be affected too: Per Sec. 138311, the bill would prohibit employee after-tax contributions in qualified plans as well as after-tax IRA contributions from being converted to Roth at any income level starting January 1, 2022.
How the Mega-Backdoor Roth Currently Works
Many workers and retirees may currently hold after-tax dollars in their current or previous employer-sponsored plans, such as a 401K, 403(b), 457, and more. Currently, the rules allow for certain retirement plans to offer employees the chance to contribute above and beyond the salary deferral maximums ($19,500 for those under 50 years of age, plus a $6,500 catch up allowance for those over age 50) on an after-tax basis up to a total of $58,000 (or $64,500 with the catch-up provision) in 2021. This is referred to as the “mega-backdoor Roth.”
Employees and ex-employees can then turn around and convert the after-tax contributions into a Roth IRA; any growth attributed to the after-tax dollars within the retirement plan cannot be converted. As long as the Roth is open for 5 years, the future growth of the investments will never be taxed after conversion.
Why It’s Important to Plan Ahead
Sec. 138311 looks to eliminate the ability to make any after-tax contributions and eliminate the ability to convert after-tax contributions after December 31, 2021. This effectively puts an end to the backdoor Roth IRA conversions and mega-backdoor Roth conversions starting in 2022.
There is always the chance the bill will be altered, and these provisions will be changed or taken out completely. However, this is a circumstance in which there is very little downside to planning ahead instead of waiting for the changes to be approved by Congress.
For those who have after-tax dollars in their current retirement plans and would like to discuss more or would like to have their tax situation reviewed to see if there is an opportunity for a backdoor Roth conversion before year-end, please contact us ASAP to schedule a conversion or appointment.
Eric Y. Oh, CFP®, ChFC®, ChSNC®
Although the information has been gathered from sources believed to be reliable, it cannot be guaranteed. Federal tax laws are complex and subject to change. This information is not intended to be a substitute for specific individualized tax or legal advice. Neither Royal Alliance Associates, Inc., nor its registered representatives, offer tax or legal advice. As with all matters of a tax or legal nature, you should consult with your tax or legal counsel for advice.