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.

Sincerely,

Eric Y. Oh, CFP®, ChFC®