Tax strategy of the rich, backdoor Roth survives the Democrats’ latest plan

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The retirement taxation strategy favored by the rich has survived in the Democrats’ latest Social and Climate Spending Plan after an earlier version put it in jeopardy.

Roth’s so-called backdoor strategies are a way for the rich to get around the income and savings restrictions that apply to Roth’s IRAs.

In the simplest case, the strategy assumes that the investor deposits money into a non-Roth account and then converts it into a Roth IRA.

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Roth IRAs provide two major benefits for wealthy individuals: neither investment growth nor withdrawals are taxed if withdrawn after 59½ years of age, and there is no mandatory minimum distribution starting at age 72, as is the case with traditional retirement accounts …

“The reason rich people do this is because they don’t want to pay taxes on their investments,” said Albert Feuer, an employee taxes and benefits lawyer in Forest Hills, New York. “The fact that they don’t have any supercharges of RMD rules [the accounts] Much more.”

The House Ways and Means Committee proposed closing loopholes as part of a broader reform package aimed at making the tax code fairer and raising money for the Democratic social and climate agenda (then projected at up to $ 3.5 trillion). The committee took action in September.

However, the $ 1.75 trillion Build Back Better program released Thursday by the White House – the result of months of negotiations between moderate and progressive lawmakers – will keep the loopholes intact.

Until we have a law, we cannot be sure what it will contain.

Albert Feuer

attorney for taxes and benefits

The new vision for tax reforms also excludes many of the other retirement measures included in the House of Representatives package, such as the new RMD rules for accounts over $ 10 million.

However, negotiations are ongoing and retirement rules could be reinstated, especially if Democrats add measures that raise the overall cost of the law and new sources of funding are needed.

These may include, for example, changes to the current $ 10,000 limit for federal tax deduction for state and local taxes.

“Until we have a law, we cannot be sure what will be in it,” Feyer cautioned.

Backdoor Mouth

Current legislation prohibits any contributions to Roth accounts for single tax payers whose annual income is exceeds 140,000 dollars. (The limit is $ 208,000 for married couples filing a joint tax return.)

However, the law allows people with higher incomes to convert from a pre-tax IRA, which has no income cap, to a Roth IRA. (They must pay income tax on the converted funds.) These pretax IRAs may hold a significant amount of money from a 401 (k) plan that has been rolled over.

(Although there is no income cap for pretax IRA contributions, people with high income cannot claim tax deduction for these contributions in excess of a certain income. varies depending on whether the person has a retirement plan or not.)

A House tax proposal would prohibit the conversion of IRA and 401 (k) funds to a Roth account. It should have been applied in 2032 for single taxpayers with taxable income of more than $ 400,000 or married taxpayers filing a joint return with income over $ 450,000.

Mega backdoor mouth

Unlike Roth’s accounts, the after-tax investment growth in these savings is tax deductible. However, wealthy investors tend to avoid taxation by quickly converting that money after taxes into a Roth IRA, a so-called megabackdoor strategy.

A House of Representatives tax proposal would ban all after-tax employee contributions and prohibit the conversion of after-tax contributions to a Roth account. This measure will apply to all income levels starting in 2022.

(According to the American Council of Plan Sponsors, only 1 in 5 401 (k) plans currently allow these after-tax deductions.)

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