A bill introduced in the House of Representatives would impose new regulations and limitations on IRAs and traditional qualified retirement accounts. This Bill proposes to increase income for various government programs in order to halt a decade-long practice of “subsidizing retirement savings once account balances reach very high levels.”
The impact of this new regulation modification may differ depending on who you ask. Some will only apply to a select group of lucky Americans who have amassed significant balances in their retirement accounts. Other regulation adjustments aim to close a nearly decade-old “loophole” that permitted otherwise unqualified savers to open a Roth IRA.
New $10 Million Cap
The proposed rule change imposes an effective cap on IRAs prior to the implementation of a new Required Minimum Distribution (RMD). This RMD has no minimum age limit, thus you might be 25 and be susceptible to it. When your IRA balance exceeds $10 million, you must distribute assets from the IRA equal to half the difference between your amount and $10 million.
For example, suppose you had an IRA balance of $11 million at the end of the year. According to the new rule, you must remove $500,000 from your IRA. There is no mention of the specific taxability of this RMD in the Bill’s text. So, if you’re under 59.5, you shouldn’t have to pay a 10% excise tax on the dividend, but the bill’s phrasing is unclear on this.
No Roth IRA If Other Retirement Account Balances Equal $20 Million
The Bill also proposes a second RMD for Roth IRAs when total retirement account balances exceed $20 million. It specifies that dividends must first originate from Roth accounts. If the amount required to fulfill the RMD exceeds the balance of the Roth IRA, investors are effectively forced to distribute 100% of their Roth IRAs to meet the RMD.
For example, if you had $20 million in a 401(k) and $5 million in a Roth IRA, your first RMD is $5 million. The second prong of this rule change compels you to withdraw this cash from your Roth IRA first. Because the RMD is the balance of your Roth IRA, you will entirely drain the Roth in this situation.
No More Sneaking In The Backdoor
The income ceiling that barred Roth IRA conversions was repealed by tax changes that went into effect in 2010. Prior to this tax law change, Americans who earned too much to start a Roth account were also barred from converting their regular IRA to a Roth account.
However, beginning in 2010, the income restriction on conversions was lifted, and Americans of all income levels were allowed to convert non-Roth IRAs to Roth IRAs. The plan was to generate tax revenue by converting standard IRA balances to Roth IRAs.
However, another option emerged for high-income people who wished they could start a Roth. They simply formed a non-deductible IRA, for which no tax deduction was taken, and then changed the non-deductible IRA to a Roth IRA a year later. Since the income restriction on conversions was removed, the “backdoor” Roth method, as it became called, became a widely publicized ruse that financial consultants marketed to their higher-income clients. It still works today as a means to get into a Roth if you can’t open one directly owing to income constraints.
The new House bill aims to seal and secure the backdoor.
The new bill clearly limits Roth IRA conversions for certain income levels, but it doesn’t end there. In addition, the new Bill intends to end “all employee after-tax contributions to qualified plans and prohibits after-tax IRA contributions from being converted to Roth regardless of income level.”
This regulatory change has a subtle but substantial significance that may affect a technique that some Americans employed in 2015.. The IRS ruled at the time that rolling a non-deductible IRA contribution into an IRA and converting it to a Roth IRA was legal. This allowed employees covered by 401(k) and similar plans to make non-deductible contributions to their 401(k)s up to the maximum contribution limits, with the option of later converting those balances into a Roth IRA. The IRS also stated at the time that no gains in these accounts would be taxed because the employee did not take a tax deduction for making the contribution. This laid the groundwork for big donations in the goal of amassing enormous sums in what would later become a non-taxable Roth IRA. We talked about it on the old podcast.
Income Thresholds For New Tax Rules
The Bill does identify income limits before being subject to these rule changes–with the exception of converting non-deductible retirement savings to Roth accounts, which is specifically stated to be prohibited regardless of income level.
These income thresholds are:
$400,000 for single filers
$450,000 for married filers
$425,000 for head-of-household filers
This means that if your taxable income falls below these amounts, these rules mostly will not apply to you.
Not Yet Law
To be clear, this Bill is still in the works. It has not yet become law. So there is still plenty of time for things to change. This Bill is unlikely to die in Congress, but it is also likely to undergo some changes before reaching the President’s desk.
