Less than two years after the Secure Act ushered in significant changes to the nation’s retirement system, more modifications may be on the horizon.
The Ways and Means Committee released the first draft of a major tax bill in September of this year. While increasing taxes to pay for other social policies and government infrastructure initiatives are the key focus, there are a number of provisions that would change retirement planning.
Congress is looking at adding retirement enhancements, the proposed tax bill is geared towards tax revenue and removing perceived “excess” benefits. Here are a couple of key points you should know about retirement taxes going into 2022.
Limits on High Income Earner Contributions to IRAs
Today, individuals with earned income who are not active participants in a 401(k) or other qualified account, whose spouse is also not an active participant, can contribute to an IRA regardless of their income or other retirement savings. For 2021, an individual can contribute up to $6,000 ($7,000 if age 50 or older) to an IRA or Roth IRA.
The new provision would limit further contributions to an individual’s IRA if the total value of the individual’s IRA and defined contribution accounts such as 401(k)s exceed $10 million at the end of the prior year, and that person earns more than $400,000 for a single or $450,000 for married filing jointly. Roth IRAs already limit contributions based on income so there would be no change with Roth, just with traditional IRAs.
Increase in Required Minimum Distributions with Large Account and High Income Earners
Today, Required Minimum Distributions (RMDs) generally kick in on retirement accounts after age 72 and are based on an IRS provided uniform lifetime distribution number. This new provision would apply a new (and much larger) RMD for those with larger accounts and significant taxable income.
If the individual’s combined traditional IRA, Roth IRA, and defined contribution retirement account balances exceed $10 million at the end of the prior year, and has taxable income above $400,000 for single filers and $450,000 for married filing jointly, then there would be a new RMD that is generally 50 percent of the aggregate amount above $10 million. So if you had $16 million, you would have a $3 million RMD since 50 percent of the $6 million over $10 million is $3 million.
If the aggregate amount exceeds $20 million, Roth IRAs and Roth accounts, like in a 401(k), would have to be distributed first until the balance falls below $20 million or the Roth accounts are depleted. This new rule would kick in for 2022.
End of “Back-Door Roth” Conversions: Section 138111
One way around this income limit was to make after-tax contributions to an IRA or a 401(k) and then to convert this over to a Roth IRA. This has often been referred to as a back-door Roth, as it went around the income limits to get money into a Roth.
This new provision would essentially end the back-door Roth IRA by disallowing any after-tax contributions to be converted or rolled into Roth accounts or Roth IRAs. This provision would kick in for the tax year 2022 so if passed it would give people some opportunity to convert these after-tax contributions by the end of 2021 into a Roth IRA. It is important to recognize that it would not end all conversions as tax-deferred dollars could still be converted to a Roth IRA.
A marriage penalty is not a penalty for married filing jointly taxpayers but when compared to single tax filers, it is possible that some married couples pay tens of thousands of dollars more in taxes than if they were not married. The new bill would make a lot of the tax thresholds and higher taxes kick in for single filers at $400,000 and for married filing jointly at $450,000.
This marriage penalty would impact retirement planning in two different ways:
- Married couples might just end up with less savings after tax than if they were single filers – allowing less money to be saved for retirement.
- Since many married couples will be more likely to fall into the highest tax rates versus single filers, there is more of an incentive for higher income married filers to save as much as possible in tax-deductible retirement accounts, like a 401(k), to reduce their tax liability and save for retirement.
It’s important to keep a lookout for other changes and how this bill progresses as it could impact your future retirement security.
In the meantime, reach out to your Johnson Wealth and Income Management Advisor to discuss how the proposed changes could affect you or your business.
We offer a wealth of services custom-designed to help you get the most from your retirement, so get in touch here today.
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