The November 3 version of the Build Back Better Act has resurrected retirement law changes that will curb high balance accounts and popular wealth building strategies including backdoor Roth IRAs and aftertax 401(k) contributions. There’s also a new $2.5 million retirement account reporting mandate, presumably to help the Internal Revenue Service with compliance. The changes are generally progressive and will hit the wealthiest taxpayers, in order to pay for the social policy and climate change bill that currently comes at a 10-year cost of $1.85 billion.
The legislation is in flux, but the fact that these provisions were in, then out, then in again, suggests that anything could happen. For now, two of the provisions are set to be effective at the start of the new year, giving taxpayers a small window to do year-end tax planning. “For back-door Roth conversions, it may be your last chance,” says Sarah Brenner, director of education at Ed Slott & Co.
The new rules would apply broadly to workplace retirement accounts like 401(k)s and 403(b)s as well as Individual Retirement Accounts (IRAs) and deferred compensation plans. Here are details pulled from the full November 3 text.
Contribution Limits On Large Accounts
There would be new contribution limits, essentially prohibiting new retirement account contributions for a taxpayer whose aggregate retirement account balances exceeded $10 million in the prior tax year. It would apply to married couples with taxable income over $450,000 (over $400,000 for singles). There are exceptions fro SEP-IRAs, SIMPLE IRAs and rollovers. But deferred compensation plans are caught up in the new rules. Also, there are more complicated rules for those whose accounts exceed $20 million. The effective date: December 31, 2028! That’s pushed back from next year in the earlier House proposal.
New Distribution Rules For Large Accounts
These same folks would have to take a special minimum withdrawal (50% of the amount over $10 million) from their retirement account in the year following any year the aggregate balance exceeded $10 million. That’s including deferred compensation. Again, there are more complicated rules for those whose accounts exceed $20 million. Effective date: December 31, 2028!
Backdoor Roths
The proposal eliminates backdoor Roth IRAs by limiting rollovers and conversions to taxable amounts. In a backdoor Roth, a taxpayer who earns too much to contribute directly to a Roth IRA can now make non-deductible contributions to an IRA and then convert it to a Roth IRA immediately owing no tax, essentially moving the money through the backdoor to a tax-free environment. The effective date for the crackdown would be after December 31, 2021.
Backdoor Mega Roths (After-tax 401(k) Contributions)
The proposal prohibits all employee after-tax contributions in 401(k)s, after December 31, 2021. It also prohibits taxpayers from converting existing after-tax IRA amounts to Roth, also after December 31, 2021. Both the backdoor Roths and backdoor Mega Roth provisions are regardless of income level. Typically, workers start making after-tax contributions, if their employer offers this, once they’ve maxed out their pre-tax and/or Roth salary deferrals. Effective date: December 31, 2021.
Roth Conversions
The proposal eliminates Roth conversions for high-income taxpayers—singles with taxable income over $400,000 and married taxpayers filing jointly with taxable income over $450,000—starting after December 31, 2031.
Information Reporting
The proposed information reporting requirement says that plan administrators—like Fidelity or whoever runs the day-to-day of your workplace retirement account—must report annually to the IRS a list of account holders, or their beneficiaries, with retirement account balances of at least $2.5 million. The information report will also include what portion of the account is in the Roth bucket, if any, as opposed to the pre-tax bucket. Effective date: December 31, 2028!
Why would the IRS need to know this? Presumably Congress is trying to get a better handle on how many large tax-favored retirement accounts are out there. The danger: Once Congress sees how many $2.5 million accounts are out there, the definition of an outsized account potentially could be reduced from $10 million. Former President Barack Obama had proposed a cap on retirement account contributions once total accounts reached the $3.4 million, based on a formula of how much annual income could be generated.
New Longer Statute Of Limitations
The Internal Revenue Service would be given three more years—six instead of three—to pursue violations related to valuation misreporting and prohibited transactions.
Further Reading:
Retirement, Death Tax, Bank Reporting Provisions Stripped From Reconciliation Bill For Now
Average Tax Refund Up 11% In 2021