A reader sent me this article on CNBC:
It linked to a summary of the legislation being considered by the House Ways & Means Committee. Among other things, the summary includes these changes with regard to retirement plans and IRAs:
Furthermore, this section prohibits all employee after-tax contributions in qualified plans and prohibits after-tax IRA contributions from being converted to Roth regardless of income level, effective for distributions, transfers, and contributions made after December 31, 2021.
However, this short description doesn’t match 100% the actual text of the bill (page 686 in the PDF). A more accurate description should be:
Furthermore, this section prohibits all employee after-tax contributions in qualified plans and
prohibitsafter-tax IRA contributions from being converted to Roth regardless of income level, effective for distributions, transfers, and contributions made after December 31, 2021.
These changes, if they become law, will effectively ban backdoor Roth and mega backdoor Roth. Specifically, effective January 1, 2022:
|Make non-Roth after-tax contribution||Allowed||Allowed|
|Convert pre-tax money to Roth||Allowed*||Allowed*|
|Convert after-tax money to Roth||Not allowed||Not allowed|
* Allowed for everyone through 2031. Still allowed after 12/31/2031 unless your income is above $400k (single) or $450k (married filing jointly).
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 to the Roth account within the employer plan.
What should you do if these proposed changes move forward and become law?
Roth Conversion Isn’t Backdoor Roth
Although backdoor Roth uses Roth conversion as its second step, a straight-up Roth conversion of pre-tax money isn’t backdoor Roth.
The bill allows 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.
Backdoor Roth – Catch the Last Bus
If the proposals become law, you’re still allowed to make nondeductible contributions to a traditional IRA but you won’t be allowed to convert them to Roth after 12/31/2021.
If you’re planning to make the nondeductible traditional IRA contribution for 2021 between January 1 and April 15 in 2022, hurry up. Make the contribution for 2021 now and convert it to Roth before December 31, 2021. If you wait until 2022 to make your nondeductible contribution, your contribution will be stuck in the traditional IRA.
If you’re planning to contribute or if you already contributed to your Roth IRA directly and there’s any chance that you will exceed the income limit for 2021 ($125,000 single, $198,000 married filing jointly), make it a backdoor Roth now. When you find you exceed the income limit, normally you can recharacterize your Roth IRA contribution to a nondeductible traditional IRA contribution and convert it in the following year but you won’t be able to do that in 2022. So go through the backdoor now. Make a nondeductible contribution to a traditional IRA and convert before 12/31/2021.
In either case, you have to do some work to prepare for the backdoor Roth. See Backdoor Roth: A Complete How-To.
For 2022 and beyond, even if you can’t do the backdoor Roth anymore when you exceed the income limit for contributing to a Roth IRA, you can still make nondeductible contributions to a traditional IRA and invest in bonds. Bonds are taxed as ordinary income outside tax-advantaged accounts. You still get tax deferral in the traditional IRA.
Mega Backdoor Roth
If your employer’s plan allows non-Roth after-tax contributions, make sure you contribute the maximum allowed in 2021 and convert them before 12/31/2021.
Some plans 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 forget to convert manually, your non-Roth after-tax contributions will be stuck.
For 2022 and beyond, you can still make non-Roth after-tax contributions to an employer plan but you’re probably better off putting the money in a regular taxable account.
You’ll need to remember to change your payroll deduction percentage for the non-Roth after-tax contribution type to zero effective the first payroll in 2022. Otherwise you’ll keep contributing after-tax money to the plan but the money won’t be converted.
What If the Proposed Changes Don’t Become Law?
The proposed changes are only proposals right now. Many proposals don’t become law. However, the moves in anticipation don’t have much of a downside.
|Proposals Become Law||No Changes|
|Complete backdoor Roth before 12/31/2021||$$ in Roth||$$ in Roth|
|Pre-emptive backdoor if possibly 2021 income over the limit||$$ in Roth||$$ in Roth|
|Complete mega backdoor Roth before 12/31/2021||$$ in Roth||$$ in Roth|
In other words, they are good moves regardless. You’re only doing them a little sooner in case you aren’t allowed to do them if the law changes.
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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