Nov 02, 2021

How Would the New Tax Proposals Affect Roth Conversions

The House Ways and Means Committee is currently considering many changes to existing tax law. While it’s important to remember that these are only proposals at this point, they do give us a good idea on what members of Congress will be looking to pass. This article will look at how Roth conversions will be affected if the Committee gets its way.

Backdoor Roth

Currently there is a loophole know as the “backdoor Roth conversion,” where an investor with AGI above the Roth contribution limit can make a non-deductible contribution to a traditional IRA, then use the conversion rules to move the contribution to a Roth IRA.

The proposed legislation would close this loophole starting next year, regardless of income level.

Mega Backdoor Roth Conversion

The “mega backdoor Roth conversion” is similar to a backdoor Roth conversion, but uses after-tax contributions from an employer plan, such as a 401(k). Many retirement plans allow participants to contribute after-tax money as either an elective or overflow contribution after the annual deferral limit has been met. As a result, many plan participants have large sums of after-tax money that they can convert to a Roth IRA either at retirement or even throughout their employment, if the plan allows. This not only helps you contribute to a Roth IRA even if your plan does not offer them, but it can also be used to get contributions into a Roth IRA above the annual contribution limit.

The proposed legislation would close this loophole starting next year, regardless of income level.

Normal Roth Conversions

The normal method of Roth conversion, where an investor takes pre-tax IRA money and pays taxes to convert it to a Roth IRA, would change under the proposed legislation, but not until 2032. The ability to make a pre-tax Roth conversion would be limited to incomes under $400,000 for single filers and $450,000 for married filers. Not only would this cause a lot of investors to be ineligible for Roth conversions, it also creates a stiff marriage penalty for dual-income married couples as there is only an extra $50,000 of income allowed over single filers.

The proposed legislation would limit who can make pre-tax Roth conversions based on income, but not until 2032. Obviously there are a lot of unknowns until the laws are passed but we at Baird Retirement Management will continue to monitor and update you on any changes that become law.


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