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IRA Changes: How New Legislation Could Impact Affluent Individuals

Major changes could be coming for IRAs if proposed legislation becomes law. A new bill currently making its way through the federal legislature would not only increase the top marginal tax rate, but would change the rules around IRAs, including prohibiting Roth IRA conversions for individuals over a certain income threshold. Introduced by Democrats, the bill aims to eliminate or limit so-called “tax shelters” from being used by wealthy individuals and families. To help you make the most informed decisions regarding your wealth, here’s a quick look at the proposed changes for IRAs and what it could mean for you.

What are the proposed changes for IRAs?

The expansive bill addresses a wide range of issues concerning corporate and personal taxes. But there are five main proposals that would impact IRAs directly.

#1 Eliminating rollovers to Roth IRAs and accounts (Sec. 138311)

Under current law, anyone can contribute to a Roth IRA through a conversion. This allows affluent individuals to make contributions to Roth IRAs despite income limitations, using what is often referred to as a “back-door Roth.” But the proposed legislation would look to eliminate that option. A summary of the legislation from the House Ways and Means Committee states, “In order to close these so-called “back-door” Roth IRA strategies, the bill eliminates Roth conversions for both IRAs and employer-sponsored plans for single taxpayers (or taxpayers married filing separately) with taxable income over $400,000, married taxpayers filing jointly with taxable income over $450,000, and heads of households with taxable income over $425,000 (all indexed for inflation).” The change would take effect for taxable years after December 31, 2031.

The bill would also prohibit “all employee after-tax contributions in qualified plans and prohibits after-tax IRA contributions from being converted to Roth regardless of income level.” That change would take effect December 31, 2021.

#2 Increasing minimum required distributions for large retirement account balances (Sec. 138302)

If the combined value of your traditional IRA, Roth IRA, and defined contribution retirement accounts surpasses $10 million at the end of a taxable year, the new bill would require a minimum distribution for the following year. The minimum distribution is generally 50 percent of the amount over $10 million. However, it only applies to individuals whose income exceeds income limits (e.g., $450,000 for a joint return).

If the combined balance of your retirement accounts exceeds $20 million, you will have to distribute that excess in one of two ways, whichever is less:

  1. The amount needed to bring the total balance in all accounts down to $20 million
  2. The aggregate balance in the Roth IRAs and designated Roth accounts in defined contribution plans

This provision would be effective for tax years beginning after December 31, 2021.

#3 Limiting IRA contributions for high-income earners (Sec. 138301)

The legislation prohibits contributions to a Roth or traditional IRA if the total value of an individual’s IRA and defined contribution retirement accounts exceed $10 million. The limit would only apply to individuals with taxable income over $400,000, married couples with income over $450,000, and heads of households making over $425,000.

The bill also adds a new annual reporting requirement for plans with aggregate account balances in excess of $2.5 million. Reports would be submitted to the IRS and the individual plan participant. The changes in this section would impact tax years beginning after December 31, 2021.

#4 Prohibiting IRA investments conditioned on account holder’s status (Sec. 138312)

The proposed bill would prohibit IRAs from holding any security if the issuer of that security requires the IRA owner to meet specific conditions for income, assets, education, or professional licensure. Any IRA holding these kinds of securities would lose IRA status. These changes would take effect for tax years beginning after December 31, 2021, but there is a 2-year transition period for those IRAs that already hold these types of assets.

#5 Prohibiting investment of IRA assets in entities where the owner has substantial interest (Sec. 138314)

Currently, IRA owners cannot invest their IRA assets in a corporation, partnership, trust, or estate in which they have 50 percent or greater interest. The bill reduces that 50 percent threshold to 10 percent for investments that are not tradable on an established securities market, regardless of whether you have a direct or indirect interest. The proposed changes would also prevent IRA owners from investing in entities in which they are an officer. As with the rule above, these changes would begin after December 31, 2021, but there is a 2-year transition period.

To understand the full breadth of the proposed legislation, check out our recent blog post, 10 Tax Proposals that Could Impact Affluent Families.

What can investors do about it?

At the time of publication, the proposed legislation has yet to be signed into law and the specifics of any particular provision have not been finalized. So, for now, it will simply be important for investors to keep tabs on how negotiations progress and what makes it into the final bill, if it does indeed become law.

In general, the best way to approach these kinds of issues is with active wealth management that responds to changing federal legislation and administrative policies. If you have an IRA or planned to use one as part of your retirement planning, now may be a good time to consider which other options are available to you that can help provide the same kinds of tax benefits. By prioritizing flexibility and balance across your portfolio, you can respond appropriately to any changes in federal policy and achieve the retirement you always envisioned.

Contact Granite Harbor Advisors today and we can schedule a call to review your goals and devise a strategy to help you achieve them.

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