The Fate of Backdoor Roth IRAs – Your Question Answered

Andrew Busa, MSPFP, CFP^®, MPAS^®, CCFC

Manager of Financial Planning

Patrick Carlson, J.D., LL.M.

Vice President of Wealth Services

This week’s reader question:

What’s the upshot of the Biden administration’s tax proposals, and what should we be most concerned about going forward?

The Biden administration maintains that any tax increases would only affect households earning $400,000 or more per year. From our read on the tax proposals released by the House Ways and Means Committee (the chief tax-writing assembly of Congress), that appears to be the case.

The legislation is aimed at two groups: High-income earners in their wealth accumulation phase and high-net-worth individuals and families in the distribution phase or who are planning their legacies with advanced estate-planning strategies. So while this does not impact everyone, the wealthy and high-income earners will end up paying more in taxes if the proposals pass.

In terms of priorities, here’s what we’re focused on as we talk through financial plans with many of you:

Anticipate income. The top marginal tax rate is expected to rise from 37% to 39.6% (the pre-Trump rate) for individuals earning more than $400,000 a year. When possible, high earners may want to pull some of next year’s income into 2021 to bypass potentially higher rates in 2022. Another option is to push last-minute charitable contributions into the beginning of 2022 (or batch this year’s contribution with next year’s, for one large contribution in 2022) to maximize the deduction.

The legislation also proposes increasing the top long-term capital gains rate from 20% to 25%. With the existing 3.8% Net Investment Income Tax layered in, that rate will actually hit 28.8% for the wealthiest Americans. If enacted—and at present it’s still a big if—this would apply to gains realized after September 13^th, 2021. In this case, there would be some limited instances where we’d suggest avoiding taking some of the largest capital gains via tax-loss harvesting or donating stocksA financial instrument giving the holder a proportion of the ownership and earnings of a company. to charities. In most cases, however, it would not impact how we advise clients.

Decide if a Roth IRAA type of account in which funds can be saved and invested without being subject to tax until the account holder reaches retirement age. (conversion) is right for you. The legislation proposes eliminating backdoor Roth conversions, which help high-income earners sidestep the Roth IRA income phaseout. (Additionally, Roth conversions would be prohibited altogether for taxpayers in the top income tax bracket beginning in the year 2032.)

The long and the short of it? If you are a high earner who’s considering a Roth conversion or backdoor Roth contributions, sooner would be better.

Review your estate plan. Legacy planning is also on the line for some. For instance, the current $11.7 million lifetime exclusion amount for gift, estate and generation-skipping transfer tax would sunset in 2022 (rather than the current sunset in 2026). After that, the exclusion would decrease to $6 million. And grantorThe creator of a trust who owns the assets to be transferred. trustsA legal document that functions as an instruction manual to how you want your money managed and spent in your later years as well as how your assets should be distributed after your death. Assets placed in a trust are generally safe from creditors and can be sold by the trustee in short order, avoiding the lengthy and costly probate process. (IDGTs) are on the chopping block, too, and could be eliminated beginning in 2022.

In both cases, you may want to make the most of these strategies now.

As with the futility of timing the market, we have no way to predict which of these (and several other) provisions will eventually become law, but it pays to plan ahead. And we’re here to help. Stay tuned for a podcast from us on this topic in the coming weeks.

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Adviser is a full-service wealth management firm, offering investment management, financial and tax planning, managed individual bond portfolios, and 401(k) advisory services. We’ve been helping individuals, trusts, institutions and foundations since 1994. Adviser Investments and its subsidiaries have over 5,000 clients across the country and over $8 billion in assets under management. Our portfolios encompass actively managed funds, ETFsA type of security which allows investors to indirectly invest in an underlying basket of financial instruments (these may include stocks, bonds, commodities or other types of instruments). Shares in an ETF are publicly traded on an exchange, and the price of an ETF’s shares will fluctuate throughout the trading day (traditional mutual funds trade only once a day). For example, one popular ETF tracks the companies in the S&P 500, so buying a share of the ETF gets an investor exposure to all 500 companies in the index., socially responsible investments and tactical asset allocation strategies, and we’re experts on Fidelity and Vanguard mutual funds. We take pride in being The Adviser You Can Talk To. To see a full list of our awards and recognitions, click here, and for more information, please visit www.adviserinvestments.com or call 800-492-6868.