- House Democrats passed the Build Back Better Act on Friday. The law includes new rules on retirement plans for the wealthy.
- The bill would create required minimum distributions for retirement accounts over $10 million, eliminate “backdoor Roth” deficiencies and restrict new contributions to larger accounts.
- The measures are part of a $1.75 trillion package to fight climate change and expand the social safety net.
The House of Representatives on Friday passed legislation that would curb how wealthy Americans use retirement plans.
The new rules are part of a broader restructuring of the $1.75 trillion tax code Build Back Better Act, which would represent the largest expansion of the social safety net in decades and the largest effort in US history to fight climate change.
House Democrats passed the bill along party lines, 220-213. It now heads to the Senate.
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Wealthy individuals with more than $10 million in retirement savings must withdraw their accounts into a new type of required minimum distribution, or RMD, each year. Lawmakers would also close the “backdoor Roth” tax loophole, which is largely used by the wealthy, and withhold individual retirement account contributions if those accounts exceed $10 million.
The measures are intended to prevent the use of 401(k) plans and IRAs as tax shelters for the wealthy.
They — along with tax provisions aimed at helping corporations and families make more than $400,000 annually — also increase revenue for universal Pre-K, Medicare expansion, renewable energy credits, affordable housing, the expanded child tax credit, and major Obamacare subsidies. .
Retirement proposals were included in an initial House tax proposal in September. However, the White House removed the retirement-planning rules from a legislative framework released on October 28, after lengthy talks with holdout members of the Democratic Party, who were concerned about some tax and other elements of the package.
However, some of the earlier retirement proposals did not reappear in the new iteration.
For example, early legislation would have disallowed IRA investments such as private equity that required owners to be so-called “accredited investors,” a status tied to funds and other factors. And some rules passed by the House on Friday will go into effect years later than originally proposed.
The law is still subject to change in the Senate, where Democrats cannot afford to lose a single vote for a measure to succeed because of unified Republican opposition.
Currently, the RMDs for account owners are tied to age rather than wealth. Roth IRA owners are also not subject to these distributions under current law. (One exception: inherited IRAs at the time of death.)
House law would add rules that would require wealthy savers of all ages to withdraw a substantial portion of their total retirement balance annually. They will likely have to pay income tax on the money.
The formula is complicated, depending on factors such as account size and account type (pretax or Roth). Here’s the general premise: Account holders must withdraw 50% of accounts valued at more than $10 million. Larger accounts must also reduce 100% of the Roth account size of more than $20 million.
Distributions will only be required for individuals whose income exceeds $400,000. The filing limit would be $450,000 for married taxpayers and $425,000 for head of household.
Will start after December 31, 2028 as per the provision Latest Available summary of the law. (This would have begun in the September House resolution after December 31, 2021.)
Roth IRAs are especially attractive to wealthy investors. Investment growth and future withdrawals are tax-free (after age 59½), and do not require withdrawals at age 72 like in traditional pre-tax accounts.
However, there are income limits for contributing to a Roth IRA. In 2021, single taxpayers cannot save in one if their income exceeds $140,000.
But current law allows high-income individuals to save in a Roth IRA through “backdoor” contributions. For example, investors can convert a traditional IRA (which does not have an income limit) to a Roth account.
Current law also allows for “mega backdoor” contributions to a Roth IRA using after-tax savings in a 401(k) plan. (This process allows the wealthy to convert much larger sums, as 401(k) plans have higher annual savings limits than IRAs.)
House legislation will address both.
First, it will prevent after-tax contributions to 401(k)s and other workplace plans and IRAs from being converted into Roth savings. This rule will apply to all income levels starting from December 31, 2021.
Second, if their taxable income exceeds $400,000 (single individual), $450,000 (married couple), or $425,000 (head of household), savers will be unable to convert pre-tax into Roth savings in IRAs and workplace retirement plans . It will start after December 31, 2031.
Current law lets taxpayers make IRA contributions regardless of account size.
However, the law would prohibit individuals from making more contributions to a Roth IRA or a traditional IRA if the total value of their joint retirement accounts (including workplace plans) exceeds $10 million.
The provisions of this section are also effective for tax years beginning after December 31, 2028. (As per RMD provisions, they would have been introduced after December 31, 2021 in the September House resolution.)
This rule applies to single taxpayers once income exceeds $400,000; married couples over $450,000; and head of household over $425,000.