Democrats put 401(k) and IRA restrictions for the rich back into their Build Back Better plan

• An updated version of Democrats' Build Back Better plan, issued Wednesday, has new rules on retirement plans for the wealthy.
• The measures were proposed by House Democrats in September, but the White House had removed them from a $1.75 trillion framework last week.
• The proposals would create required minimum distributions for retirement accounts of more than $10 million, eliminate "backdoor Roth" loopholes and prohibit new contributions to large accounts.

House Democrats proposed several rules to curb retirement accounts of the rich, part of a broad restructuring of the tax code tied to the party's Build Back Better social and climate spending package.

Wealthy individuals with more than $10 million in retirement savings would have to draw down their accounts each year, in a new type of required minimum distribution, or RMD, according to updated legislation issued Wednesday evening by the House Budget Committee.

Lawmakers would also close "backdoor Roth" tax loopholes for the rich, and prohibit further individual retirement account contributions once those accounts exceed $10 million.

The measures are aimed at curbing the use of 401(k) plans and IRAs as tax shelters for the wealthy.

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The proposals were included in an initial House tax proposal in September. However, the White House stripped the retirement-plan rules from a $1.75 trillion framework issued Oct. 28 after lengthy negotiations with holdout members of the Democratic party, who were concerned about some tax and other elements of the package.

Some of the earlier retirement proposals didn't re-appear in the new iteration, however.

For example, the initial legislation would have disallowed IRA investments like private equity that require owners to be so-called "accredited investors," a status tied to wealth and other factors.

And some of the rules would kick in years later than originally proposed.

The legislative draft, which is still subject to change, aims to raise taxes on households making more than $400,000 a year and corporations in order to fund expanded access to child care, home care and health care; cut taxes for low and middle earners; and invest in measures to curb climate change.

Republicans staunchly oppose the plan. Democrats, who have razor-thin margins, can't afford to lose a vote on the Senate and hardly any in the House for the measure to pass.

It's unclear how will the Senate will ultimately land on the tax measures and other aspects of the broad package.

"It's sort of like a chess game," Robert Keebler, an accountant and estate planner based in Green Bay, Wisconsin. "When will the Senate make its move?"

RMDs for $10 million accounts

Currently, RMDs for account owners are tied to age instead of wealth. Roth IRA owners also aren't subject to these distributions under current law. (One exception: inherited IRAs at death.)

The House legislation would add to those rules, asking wealthy savers of all ages to withdraw a large share of aggregate retirement balances annually. They'd potentially owe income tax on the funds.

The formula is complex, based on factors like account size and type of account (pretax or Roth). Here's the general premise: Accountholders must withdraw 50% of accounts valued at more than $10 million. Larger accounts must also draw down 100% of Roth account size over $20 million.

The distributions would only be required for individuals whose income exceeds $400,000. The threshold would be $450,000 for married taxpayers filing jointly and $425,000 for heads of household.

The provision would start after Dec. 31, 2028. (It would have begun after Dec. 31, 2021 in the September House proposal.)

People with millions of dollars in retirement savings would likely change their financial plans to circumvent the rules' impact if they're adopted, Keebler said.

"There may be people already at $6 million [for example] who might decide not to put more money into their IRAs, but into life insurance or other statutory tax shelters," Keebler said.

Backdoor Roth

Roth IRAs are especially attractive to wealthy investors. Investment growth and future withdrawals are tax-free (after age 59½), and there aren't required withdrawals at age 72 as with traditional pre-tax accounts.

However, there are income limits to contribute to Roth IRAs. In 2021, single taxpayers can't save in one if their income exceeds $140,000.

But current law allows high-income individuals to save in a Roth IRA via "backdoor" contributions. For example, investors can convert a traditional IRA (which doesn't have an income limit) to a Roth account.

Current law also allows for "mega backdoor" contributions to a Roth IRA using after-tax savings in a 401(k) plan. (This process lets the wealthy convert much larger sums of money, since 401(k) plans have higher annual savings limits than IRAs.)

The House legislation would address both.

Firstly, it would prohibit any after-tax contributions in 401(k) and other workplace plans and IRAs from being converted to Roth savings. This rule would apply to all income levels starting after Dec. 31, 2021.

Secondly, savers would be unable to convert pre-tax to Roth savings in IRAs and workplace retirement plans if their taxable income exceeds $400,000 (single individuals), $450,000 (married couples), or $425,000 (heads of household). It would start after Dec. 31, 2031.

IRA contribution limits

Current law lets taxpayers make IRA contributions regardless of account size.

However, the legislation would prohibit individuals from making more contributions to a Roth IRA or traditional IRA if the total value of their combined retirement accounts (including workplace plans) exceeds $10 million.

The provisions of this section are effective tax years beginning after December 31, 2028. (It would have begun after Dec. 31, 2021 in the September House proposal.)

The rule would apply to single taxpayers once income is over $400,000; married couples over $450,000; and heads of household over $425,000.

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