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Proposed Tax Changes to Close Backdoor ROTH
Old 09-14-2021, 01:37 PM   #1
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Proposed Tax Changes to Close Backdoor ROTH

Looks like the days of the backdoor ROTH and conversions may be coming to an end soon for high income earners. In particular the 401k after-tax contribution mega backdoor ROTH may end for all. That impacts me



"The bill also 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 Dec. 31, 2021"


https://www.thinkadvisor.com/2021/09...ackdoor-roths/
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Old 09-14-2021, 02:50 PM   #2
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You made me go back and look to see how much DW and I backdoor ROTH'ed while at Megacorp. We moved ~$375K into ROTHs via backdoor conversion from 2012 to 2016. Today the two accounts are worth $745K, so that equates to a $370K tax free gain.

This law never made much sense to me, as we made too much to contribute to a ROTH in the traditional way. But hey, I'll take it.
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Interesting article on proposed IRA and Roth for high earners
Old 09-15-2021, 06:10 PM   #3
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Interesting article on proposed IRA and Roth for high earners

The Roth conversion may be going away for those with incomes above $400k. Not sure if that means that you can convert up to $400k with zero earnings or what...

There are a lot of proposed changes here.

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https://www.cnbc.com/2021/09/13/hous...e-wealthy.html
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Old 09-15-2021, 07:58 PM   #4
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I don't have a problem with any of those proposals.... the whole IRA program was intended to allow middle income taxpayers to save for retirement with an incentive of tax savings.

Given their very names, it should be obvious that the backdoors were not intended and should be closed and locked.

I also don't have any problems with restrictions on IRAs above certain limits.
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Old 09-15-2021, 08:21 PM   #5
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I’ve heard that the number of investors/ taxpayers these MEGA IRAs and rules would apply to is a relatively small number like under 25,000.
The provisions impacting those making over $400k would be much more far reaching.
This would close loopholes for the very wealthy.
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Old 09-15-2021, 09:43 PM   #6
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I think this is just going to add more layers of complexity to the tax codes.

Not that I will in my lifetime get into the "over $400k annual income" club. But as is (most) often the case with IRS "rules", that $400k cutoff today may become $200k the next time the rich aren't deemed to be paying enough. Then $100k the time after that, then soon it applies to everyone.
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Old 09-15-2021, 09:54 PM   #7
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Thought it worth including some of the details
Quote:
Most of the changes would start in 2022.

Wealthy individuals with retirement accounts exceeding $10 million would be prohibited from contributing extra savings and would have a new required minimum distribution each year, according to an outline of tax legislation unveiled Monday by the House Ways and Means Committee.

The bill would also repeal so-called Roth conversions in individual retirement accounts and 401(k)-type plans for those making more than $400,000 a year. It would also prevent savers from using the “mega-backdoor Roth” strategy, regardless of income level.

Further, the legislation would prohibit individual retirement accounts from holding investments that require buyers to be accredited investors, a status generally reserved for wealthy investors.
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Old 09-15-2021, 10:01 PM   #8
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There’s a good write up about this proposal on finance buff’s blog (no affiliation).

https://thefinancebuff.com/what-if-c...door-roth.html

I’ll be sad to see this go, but agree that it’s always been a bit of a loophole.
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Old 09-15-2021, 10:24 PM   #9
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Just an aside for say I'm always intrigued by the use of the term loophole. People follow the laws that are on the books. If some of those were in fact "mistakes", techical corrections acts are the solution.

The fact that the laws have been on the books for years or decades suggests to me one of two possibilities:

1. They are desired or intended by Congress or

2. There is no consensus to change them, which means they remain the law of the land

In either case they are not loopholes in my view.

As far as the substance of the changes, they make the tax code more complicated and reform will no doubt soon be needed to fix this if any of this passes.

I'm not a fan of these changes because they simply set the stage for them to be lowered and impact more.people at a future date.

These changes would however seem more palatable if the proceeds were used to balance the budget, instead of to only partially fund new entitlements, when existing programs are near the brink of solvency.

Just does not seem smart to me. End rant.
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Old 09-15-2021, 10:28 PM   #10
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Originally Posted by Montecfo View Post

The fact that the laws have been on the books for years or decades suggests to me one of two possibilities:

1. They are desired or intended by Congress or

2. There is no consensus to change them, which means they remain the law of the land

In either case they are not loopholes in my view.

As far as the substance of the changes, they make the tax code more complicated and reform will no doubt soon be needed to fix this if any of this passes.

I'm not a fan of these changes because they simply set the stage for them to be lowered and impact more.people at a future date.

These changes would however seem more palatable if the proceeds were used to balance the budget, instead of to only partially fund new entitlements, when existing programs are near the brink of solvency.

Just does not seem smart to me. End rant.


Agree with every one of your points. Succinct rant, every one of your points is valid.
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Old 09-16-2021, 04:47 AM   #11
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Originally Posted by RetireeRobert View Post
Agree with every one of your points. Succinct rant, every one of your points is valid.

I understand your point, but I would respectfully disagree. The tax code, like all parts of the law, is a living/dynamic thing that reflects the political and financial realities of the times. Given the physical size of the bills introduced by the Congress, I genuinely doubt that very few people have read the entirety of any proposed tax legislation, and it therefore doesn’t surprise me a bit that there would be unforeseen or unintended consequences (e.g. loopholes). Beyond that, the financial industry has an army of lawyers/planners who have the resources to scrutinize the tax code to find opportunities to exploit/expand the laws’ original intent. It is my belief, that nobody who was involved in creating legislation ever intended for someone like Peter Thiel accumulate hundreds of millions (if not billions) of dollars in a Roth IRA effectively avoiding paying taxes that would have been reasonably expected to be collected. I’m not arguing that he broke the law; I’m not even arguing that the preventing such accumulation in a Roth is even right or fair. I’m just of the belief that those who wrote the legislation never intended for the vehicle to be used in this manner. No reasonable person would create a contraption that would allow so few people to enormously benefit. Finally, I would again disagree with your statement about achieving a consensus to change the law….it may not be a broad consensus, but given the likelihood of the legislation passing, seems to me there is one. I’m all in favor a having a stable tax code so folks can plan and make decisions without worrying about the rug being pulled out from underneath them, but anyone who makes a financial transaction (e.g. buys a house with a big SALT bill) should know that the tax treatment of that transaction is only as good as the current Congress and President.
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Old 09-16-2021, 04:58 AM   #12
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Ed Slott calls them Backdoor Roths.
Quote:
The plan “would be an all-out ban on backdoor Roths from IRAs and mega backdoor Roths from plans, regardless of income,” Slott said. “At least this inadvertently finally answered the question of whether backdoor Roths are legal. They obviously are, because if they weren’t Congress would not need to end them.”
I trust his terminology and conclusions throughout this article.
https://www.thinkadvisor.com/2021/09...ira-crackdown/
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Old 09-16-2021, 06:00 AM   #13
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Originally Posted by ExPatKiwi View Post
Looks like the days of the backdoor ROTH and conversions may be coming to an end soon for high income earners. In particular the 401k after-tax contribution mega backdoor ROTH may end for all. That impacts me



"The bill also 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 Dec. 31, 2021"


https://www.thinkadvisor.com/2021/09...ackdoor-roths/
I did not know about this 'back door' Roth until a couple of years ago, however, as I analyze, it has the same effect as taking what you would put in an IRA and converting it to a Roth in the same year. I'm guessing the big gain here would be the ability to get around the income limitations for an outright Roth contribution.

However, I have an SEP IRA and can contribute up to 25% of my net profits there up to a much larger amount than that allowed by an employee tax-deferred program. I could convert that in the same year, if I wish.

In any case, one still has to pay taxes on the conversion as if it is income up to the tax bracket that one would choose for the conversion. I guess it allows one to quickly 'convert' and then allow for tax-free growth over a longer period of time....

Based on what I see, the proposed law would not stop what I was doing above as long as I properly recognize the conversion and pay the tax.
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Old 09-16-2021, 06:45 AM   #14
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Originally Posted by deserat View Post
I did not know about this 'back door' Roth until a couple of years ago, however, as I analyze, it has the same effect as taking what you would put in an IRA and converting it to a Roth in the same year. I'm guessing the big gain here would be the ability to get around the income limitations for an outright Roth contribution.

However, I have an SEP IRA and can contribute up to 25% of my net profits there up to a much larger amount than that allowed by an employee tax-deferred program. I could convert that in the same year, if I wish.

In any case, one still has to pay taxes on the conversion as if it is income up to the tax bracket that one would choose for the conversion. I guess it allows one to quickly 'convert' and then allow for tax-free growth over a longer period of time....

Based on what I see, the proposed law would not stop what I was doing above as long as I properly recognize the conversion and pay the tax.
This is not exactly how mine worked. Starting in 1990, in addition to pre-tax money, I contributed to my 401K with post-tax money. Then in 2012, I realized that I could take an in-service withdrawal of my post-tax money and roll it over into a ROTH IRA. Fido had kept track of all the gains associated with that post-tax money and all those gains had to be rolled into a taxable rollover IRA at the same time, that I rolled my post tax money into a ROTH. No tax was due on the ROTH money, just future tax on the rollover IRA money (which I would have owned anyway if I left it within the 401K). The perk was that all my future gains would now be tax free since it was now in a ROTH. Also, no conversion tax was due on the ROTH money as it was post-tax money. It seemed too good to be true, but FIDO assured me it was legit and IRS has never question it.
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Old 09-16-2021, 06:50 AM   #15
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Old 09-16-2021, 07:09 AM   #16
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Originally Posted by Mark1 View Post
This is not exactly how mine worked. Starting in 1990, in addition to pre-tax money, I contributed to my 401K with post-tax money. Then in 2012, I realized that I could take an in-service withdrawal of my post-tax money and roll it over into a ROTH IRA. Fido had kept track of all the gains associated with that post-tax money and all those gains had to be rolled into a taxable rollover IRA at the same time, that I rolled my post tax money into a ROTH. No tax was due on the ROTH money, just future tax on the rollover IRA money (which I would have owned anyway if I left it within the 401K). The perk was that all my future gains would now be tax free since it was now in a ROTH. Also, no conversion tax was due on the ROTH money as it was post-tax money. It seemed too good to be true, but FIDO assured me it was legit and IRS has never question it.
OK -so you paid the taxes on the income before it went into the IRA - so it was not tax-deferred, it merely allowed you to move that income to the Roth through the tax-deferred vehicle; I get it now. Those funds were able to get into the Roth when otherwise they would end up in a taxable account.

Sweet.....
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Old 09-16-2021, 07:24 AM   #17
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<mod note> Let’s please stick to the thread topic and leave the generic tax/spending rants for another discussion.
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Old 09-16-2021, 07:39 AM   #18
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Although it won't effect me anymore, I'm truly sorry to see the "mega-backdoor" and "backdoor" Roth conversions go away. Although they were needlessly convoluted procedures, I'd argue that the net effect was a deserved perk for a lot of hardworking folks. I'd guess that maybe 10% of the 55,000 fellow employees at my former employer used the mega-backdoor through the Fidelity 401K. Those people aren't fat-cats by any stretch, although they work long, hard hours for good pay. And pay a lot of taxes. The closing of the "backdoors" is a very real eventual big tax increase on a whole lot of people who make less than the $400K per year that was supposed to be sacrosanct. This doesn't just effect a hedgefundy with a billion$ Roth.
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Old 09-16-2021, 10:17 AM   #19
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If this affects Roth conversions for people making over $400K per year, any landlords thinking of the possibility of selling their property should wait until the end of the year to do conversions.

When selling a rental, the potential of the sale profit could push normal income up very high for the one year.
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Old 09-16-2021, 10:26 AM   #20
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I am kind of confused and not sure it matters to too many people, but. The articles talk about earnings limits for individuals, head of household, and couples. Are the rules changing for combined "Individual" accounts or combined "Individual accounts"? Meaning spouses have a $10/20M limit combined or each. It also sounds like the $10/20M limits only apply ~if you have income over the series of $400k thresholds. That would be an amazingly hard needle to thread...

How's that for an ER nerd contemplating the esoteric....
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