Backdoor Roth 401(okay) and IRA guidelines for the rich survive — for now


Senator Joe Manchin, DW.Va., walks in front of the Senate Chamber on Capitol Hill on December 9, 2021.

Kent Nishimura | Los Angeles Times | Getty Images

The “Back Door Roth” tax strategy, used primarily by wealthy retirees and slated to be killed next year, has survived – for now.

The loophole allows wealthy 401 (k) and individual retirement account holders to save on a Roth-style account, protecting future investment growth from taxes. Roth accounts are generally taboo for such investors due to an income limit.

The Democrats wanted to end the rules from 2022 under the Build Back Better Act, a package of roughly $ 1.75 trillion in climate and social investments combined with tax changes for wealthy Americans.

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House Democrats passed the bill in November; Senate Democrats hoped to get it passed by the end of the year. But Senator Joe Manchin, DW. Va., Thwarted these plans on Sunday and announced that he would not support the measure in its current form. Manchin’s vote is crucial to pass the law because of the united republican opposition.

The delay means that the backdoor Roth strategy ban won’t go into effect as planned in early 2022 – which means taxpayers may not have to try to use the rules before they are ostracized.

If Democrats pass the bill early next year, it is likely (though not certain) that Congress will postpone entry into force until 2023, experts said.

“I don’t think you’ll have an effective date by the middle of the year,” said Steven Rosenthal, senior fellow at the Urban-Brookings Tax Policy Center. “It’s too cumbersome.”

“You may have thought you should run around to get a back door Roth in place,” said Rosenthal. “But you don’t have to race.”

The back door Roth rules were among the few targeted at wealthy retirement savers who would have started the next year. Others, like one creating new distribution rules for retirement assets greater than $ 10 million, would have started doing so later in the decade.

The backdoor Roth contribution ban would affect all taxpayers, unlike most other aspects of the Democrats’ tax proposals, which would affect households with incomes of $ 400,000 or more.

Backdoor Roth

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Roth accounts are particularly attractive to wealthy investors. Investment growth and future withdrawals are tax-free from the age of 59½ years and no withdrawals are required by the age of 72 as with traditional pre-tax accounts.

However, there are income limits for contributing to Roth IRAs. In 2021, single taxpayers cannot save all at once if their income exceeds $ 140,000. (The limit is $ 208,000 for married couples filing a joint tax return.)

High-income individuals can bypass the income limit by making a “back door” contribution. Investors who save before taxes in a traditional IRA can convert that money into Roth; You pay taxes on the conversion, but shield the proceeds from future taxes.

(There is no pre-tax income limit for contributions to IRAs. However, wealthy taxpayers are unlikely to be able to deduct this contribution from their taxes, as there is for low-income earners.)

Mega back door Roth

Company pension plans (like a 401 (k) plan) do not prohibit wealthy investors from the Roth savings. But another loophole – the “Mega Backdoor Roth” strategy – allows them to invest large sums of money in 401 (k) s and IRAs well above the typical annual contribution limits.

This process involves making an after-tax contribution to a 401 (k) account and converting those savings into a Roth-style 401 (k) or IRA account.

The IRA and 401 (k) rules prohibit annual dues greater than $ 6,000 and $ 19,500, respectively, in 2021. (These limits are higher – $ 7,000 and $ 26,000 – for those aged 50 and over.)

However, some employers allow savers to invest tens of thousands of additional funds through after-tax contributions due to different tax regulations.

In 2021, employees on a 401 (k) plan could save an additional $ 38,500 through after-tax contributions, which can then be converted into Roth funds. (It’s $ 45,000 for people age 50 and over.)

However, most employers do not allow such contributions. About 20% of the 401 (k) plans did so in 2020, according to the Plan Sponsor Council of America. The proportion is almost double that of the largest companies with over 5,000 employees participating in the plan.

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