[Updated and rewritten on January 1, 2022 after Congress decided to postpone the Build Back Better legislation to 2022.]
President Biden and Congress have been working on the Build Back Better legislation for some time. The House already passed a bill. The Senate has come up with a draft bill. There are some differences between the two versions and there are still some disagreements in what exactly should go into the Senate bill. However, one thing not in disagreement is that Congress wants to ban the backdoor Roth and the mega backdoor Roth. Both the House and the Senate agree this will be part of the Build Back Better package if and when it passes.
These changes, if they become law, will have these effects:
|Make non-Roth after-tax contribution
|Convert pre-tax money to Roth
|Convert after-tax money to Roth
* Allowed for everyone through 2031. Still allowed after 12/31/2031 unless your income is above $400k (single) or $450k (married filing jointly).
If the Build Back Better passes, you can still make non-Roth after-tax contributions but you can’t convert those non-Roth after-tax contributions to Roth. This ban covers converting after-tax money from a traditional IRA to a Roth IRA, rolling over after-tax contributions from an employer plan to a Roth IRA, and converting after-tax money in an employer plan to the Roth account within the plan.
Due to the disagreements in other parts of the bill unrelated to backdoor Roth and mega backdoor Roth, President Biden and Congress decided to continue their discussion in 2022. If and when they finally reach an agreement, the effective date will be sometime in 2022 or later.
What should you do if these proposed changes move forward and become law in 2022?
Roth Conversion Isn’t Backdoor Roth
First of all, many people confuse backdoor Roth with a plain vanilla Roth conversion. Although backdoor Roth uses Roth conversion as its second step, a straight-up Roth conversion of pre-tax money isn’t backdoor Roth.
The bills in the House and the Senate allow converting pre-tax money to Roth by anyone for at least 10 years through the end of 2031. Starting in 2032, only those with a high income won’t be allowed to convert pre-tax money. That’s 10 years from now. Who knows what will change by then. If you’re only worried about converting pre-tax money to Roth, please understand it isn’t affected for at least 10 years.
Backdoor Roth – 2021
If the proposals become law in 2022, you’re still allowed to make nondeductible contributions to a traditional IRA for 2021 before April 15, 2022 but you won’t be allowed to convert them to Roth after an effective date to be determined.
If you already contributed to your Roth IRA for 2021 directly and you find out that your 2021 income exceeded the income limit ($125,000 single, $198,000 married filing jointly), you can still recharacterize your Roth IRA contribution to a nondeductible traditional IRA contribution but it’s possible you won’t be able to convert it to Roth in 2022.
Mega Backdoor Roth – 2021
Some employer plans allow non-Roth after-tax contributions and do an automatic conversion on the same day. You’re covered if you signed up for the automatic conversions. If your plan doesn’t offer automatic conversion and you must convert manually, it’s possible your non-Roth after-tax contributions will be stuck after Congress passes the Build Back Better bill.
What About 2022?
As the President and Congress continue their discussion into 2022, we don’t know what the final outcome will be. If you normally do the backdoor Roth in January, should you proceed as usual or should you wait until it’s clear which way it will go? If you’re currently making non-Roth after-tax contributions to an employer plan, should you continue or pause those after-tax contributions?
I see these four possible scenarios:
1. Law Doesn’t Change
It’s possible the discussion reaches an impasse and the bill doesn’t pass in the Senate. If you proceed as usual, you’ll get your backdoor Roth in January. If you wait until say March to learn that the legislation died, you still have time to complete your backdoor Roth and mega backdoor Roth. The difference is only in when, not whether, you complete your backdoor Roth and mega backdoor Roth.
2. Law Changes, Effective 1/1/2023
It’s also possible that the bill passes in the Senate in 2022 with a ban of backdoor Roth and mega backdoor Roth effective 1/1/2023. As far as 2022 is concerned, this is the same as the previous scenario. Either way you’ll get it done in 2022 and the only difference is in which month.
3. Law Changes, Effective Mid-Year with No Advance Warning
Another possibility is the bill passes with no advance warning. Say the bill passes on March 10 with an effective date of March 11. They often do that to avoid a last-minute mad dash to beat the clock. By the time the law changes, it’s already too late to make any changes. Meanwhile, those who performed backdoor Roth and mega backdoor Roth before the effective date won’t be affected.
In this scenario, you’re better off doing the backdoor Roth and mega backdoor Roth before the law changes. You snooze, you lose.
4. Law Changes, Effective 1/1/2022
It’s also possible that the tax law changes will be made retroactive to January 1, 2022. It’s legal and it happened before.
Currently, a Roth conversion or an in-plan Roth rollover can’t be reversed (“recharacterized”). If you already completed the conversion before it’s made illegal retroactively, I imagine they will also give you a one-time exemption to undo it. If you go ahead under the current law, you’ll have the hassle of unwinding your conversion.
|Bill fails to pass
|$$ in Roth
|$$ in Roth
|Law changes, effective 1/1/2023
|$$ in Roth
|$$ in Roth
|Law changes mid-year
|$$ in Roth
|Law changes retroactively to 1/1/2022
|no extra work
Whether you should go ahead as soon as you can or wait until it’s clear on how the law will change depends on how badly you don’t want to miss an opportunity versus how much you hate the possible hassle of having to undo a conversion. I will proceed ASAP in my personal accounts, but only you can make the decision for yourself.
A Big Loss?
Is it a big loss if the proposed changes become law and you can’t do backdoor Roth and mega backdoor Roth anymore?
It’s a loss because tax-free growth beats tax deferral on the earnings or the lower tax rates on qualified dividends and long-term capital gains. However, the power of saving and investing comes from making the contributions to begin with, not from how the investment returns are taxed.
A taxable account always works. In the end, even if all the tax-advantaged accounts go away and all the returns are taxed as regular income, those who save and invest more will still succeed. You take advantage of all available tax savings but you can’t stake your success on specific tax breaks.
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