The following discussion is one that I believe many will find frustrating. Over the summer of 2021, private information was leaked to the public regarding famed entrepreneur and venture capitalist, Peter Thiel. Chiefly, that he has amassed a Roth IRA with a balance exceeding $5 billion dollars – yes, billion with a B. He did so by funding the account many years ago with non-registered shares of PayPal (a company he co-founded). While there are a variety of opinions regarding whether someone should be able to amass such an enormous tax-free account in that way, the frustrating aspect is that the proposed legislative changes to “combat” such a circumstance miss the mark entirely. Rather than addressing the specific case of Thiel, sweeping measures have been proposed that have the potential to affect Americans of all income levels.
For high income individuals, it can often be a challenge to take advantage of the benefits offered by Roth IRA accounts. Particularly, the modified adjusted gross income (MAGI) limits on making contributions ($140k for individuals & $208k for married filers) prohibit these taxpayers from making any contribution (through traditional means) at all. Even for those with MAGI below these thresholds, the traditional contribution limits are low relative to other common retirement savings vehicles.
Historically, there has been one effective “loop-hole”, the Roth conversion. The process has many intricacies, but simply put, taxpayers may choose to take a portion of their tax-deferred retirement account (401(k), IRA, etc.), pay the income tax on that amount today, and place the remaining proceeds into a Roth IRA to grow tax-free.
While it is unlikely that the practice of Roth conversions will be eliminated completely, the most recent tax proposal in the House of Representatives aims to limit the scope of this strategy from a number of angles. For this discussion it specifically targets the “Mega-Roth” Conversion through employer sponsored retirement accounts.
Currently, employees may contribute as much as $19,500 ($26,000 if age 50 or older) in pre-tax dollars to their 401k plan. A lesser-known fact is that total contributions to the account are allowed up to $58,000 ($64,500 if age 50 or older) – which means, an additional $38,500 can be contributed to the account in the form of after-tax dollars to a Roth account*. The proposed legislation would eliminate the Roth treatment of these after-tax dollars. Instead, they would be characterized in much the same way as an after-tax brokerage account at your preferred custodian. What’s more is that this change will be irrespective of the employee’s income level. Even if you make less than the current income limitations, but simply choose to save diligently, this proposed legislation will remove the strategy of such contributions for you as well. If passed, this bill would take affect for any contributed dollars on or following January 1st, 2022.
It is uncertain just how much, if any, of the proposed tax law changes will make it into law, but such a significant proposal with a Congress amendable to making changes should be reason enough to consult your financial advisor and CPA to understand just how these changes may affect your own financial plan.
*It is important to note that not all employer plans allow this practice within their own guidelines, but many notable firms do.
