7 ways the new tax bill could impact retirement planning


The Ways and Means Committee released the first draft of a major tax bill this week. While its primary purpose is to raise taxes to pay for other social policies and government infrastructure initiatives, there are a number of provisions that would alter retirement planning.

You can see a summary of the Ways and Means Committee here. Most of this bill as far as retirement planning is concerned is more about tax revenue and adding new restrictions. It is not intended to expand access to retirement or improve retirement security for Americans like other bills submitted to Congress, such as the SECURE Act 2.0.

As Congress plans to add retirement enhancements, the tax bill released this week focuses on tax revenue and the removal of “excess” perceived benefits.

Let’s take a look at seven different ways the tax bill would affect retirement.

(1) Limits on contributions of high income earners to IRAs: Sec. 138301

Today, people with earned income who are not actively participating in a 401 (k) or other qualified account, whose spouse is also not an active participant, can contribute to any IRA. their income or other retirement savings. For 2021, a person can contribute up to $ 6,000 ($ 7,000 if they are 50 or older) to an IRA or Roth IRA.

The new provision would limit any additional contribution to a person’s IRA if the total value of the person’s IRA and defined contribution accounts, such as 401 (k) accounts exceeds $ 10 million at the end of the period. the previous year, and that person earns more than $ 400,000 for a single person or $ 450,000 for jointly married filing. Roth IRAs already limit contributions based on income, so there would be no change with Roth, just traditional IRAs.

(2) Significant increase in minimum distributions required with large accounts and high income: Sec. 138302

Today, Minimum Required Distributions (RMDs) typically come into effect on retirement accounts after age 72 and are based on a uniform life span provided by the IRS. broadcast number (basically a life expectancy number) and the value of the account at the end of the previous year. This new provision would apply a new (and much larger) RMD for those with larger accounts and significant taxable income.

If the combined balances of the individual’s Traditional IRA, Roth IRA, and Defined Contribution Retirement Account exceed $ 10 million at the end of the previous year and have taxable income greater than $ 400,000 for single filers and $ 450,000 for joint filing, then there would be a new RMD that is typically 50 percent of the overall amount above $ 10 million. So if you had $ 16 million, you would have an RMD of $ 3 million since 50% of the $ 6 million over $ 10 million is $ 3 million.

Developing this rule further, if the total amount exceeds $ 20 million, the Roth IRA and Roth accounts, as in a 401 (k), should first be distributed until the balance falls below $ 20 million. dollars or Roth accounts run out. This new rule would come into effect for 2022.

(3) Roth Conversion Limits for High Income Employees: Section 138111

In 2010, all limits on Roth conversions of assets from traditional IRAs or income-based defined contribution plans were removed. This means that under current law anyone, regardless of their income level, can convert assets between IRAs and Roth IRAs.

However, there are income-based limits for directly contributing to a Roth IRA. For example, in 2021, if you earn more than $ 140,000 for a single filer or $ 208,000 for a joint filing, you cannot contribute directly to a Roth IRA. This bill would prevent Roth conversions in any year in which a taxpayer had taxable income greater than $ 400,000 for single filers and $ 450,000 for jointly married filers. In essence, high income people in the future would be prohibited from making Roth IRA conversions. However, even if this bill as drafted were passed today, this provision would not come into force until tax year 2032.

(4) End of “Back-Door Roth” conversions: Section 138111

As I just said, there are income limits for contributing to a Roth IRA. However, one way around that income limit was to make after-tax contributions to an IRA or 401 (k) and then convert it to a Roth IRA. This was often referred to as a backdoor Roth because it bypassed income limits to get money into a Roth.

Going forward, this new provision would essentially end the Roth IRA backdoor by prohibiting the conversion or transfer of any after-tax contribution into Roth or Roth IRA accounts. This provision would come into effect for the 2022 tax year, so if passed, it would give people the ability to convert those after-tax contributions by the end of 2021 into a Roth IRA. It’s important to recognize that this wouldn’t end all conversions, as tax-deferred dollars could still be converted to Roth IRAs.

(5) Limitation of certain IRA investments: Section 138312

IRAs have a number of investments and transactions that are not permitted. For example, some auto-trade transactions are not allowed and are considered prohibited transactions. Additionally, investments in collectibles and life insurance are prohibited transactions inside IRAs.

The new provision would prohibit other types of investments that require the owner of the IRA to obtain certification, achieve a minimum asset level, or obtain a certain level of education. In essence, this would end investments only for accredited investors in IRAs, private placements and even some other funds with asset limits might have to change. This would go into effect for 2022 but would have a two-year grace period to resolve any existing investment issues in an IRA due to this rule change. This could force a number of current IRA owners to change their IRA investments and allocations very quickly.

(6) Limitation of auto-trade transactions of IRA owners: article 138314

Currently, an IRA owner cannot invest his IRA assets in a business in which he has a 50 percent or greater interest. As such, you can have a lot of control and still invest in a business within your IRA today. For example, being a manager of a company, like the CEO, with less than 50% ownership does not create a problem for investing in the company today within his IRA.

However, this new rule would lower the threshold from 50 percent to 10 percent. In addition, the bill would prevent investing in an entity that is not traded in an established market in which the owner of the IRA is an officer of that company, regardless of ownership. This would come into effect for 2022 but would allow a two-year transition period for existing IRAs that already have these assets. This rule could impact many self-directed IRAs and cause people to part with the businesses and investments they have purchased in their IRA.

(7) Marriage penalty

Finally, I wanted to underline the “marriage penalty” found throughout this bill. A marriage penalty isn’t much of a penalty for married taxpayers filing jointly, but compared to single filers, it is possible that some married couples pay tens of thousands of dollars more in taxes than if they weren’t. not married.

The new bill would ensure that many higher tax and tax thresholds would apply to single filers at $ 400,000 and married people to jointly file at $ 450,000. So if the two were not married, they could have a potential income of $ 400,000 each, hence $ 800,000 as two single tax filers, before reaching the top tax bracket of 39.6. % instead of $ 450,000 of common income.

This marriage penalty would impact retirement planning in two different ways: First, married couples might simply end up with less after-tax savings than if they were single, thus saving less money. money for retirement. Second, because many married couples will be more likely to fall into the highest tax rates compared to single tax filers, high-income married tax filers have a greater incentive to save as much as possible in tax-deductible retirement accounts. tax, like a 401 (k), to reduce their tax liability and to save for their retirement.

Keep in mind that this bill is just one of many bills currently circulating in Congress that could have an impact on retirement planning. Also, this is in fact a bill and likely will not be the final bill. As we have seen in the past, when it comes to major tax reform, a lot can change between the first draft and the final bill. It is also not expected that there will be even enough votes for this current bill in Congress. Stay tuned for other changes and developments in this bill as they could impact your future retirement security.

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