The Changes to 401(k) and IRA Rules for 2022

November 16, 2021

As Congress continues to debate details of the Build Back Better Act, there are a lot of potential legislative changes on the table, from education to the environment to healthcare.

But for investors, some of the biggest changes lie in alterations to 401(k) and IRA rules—changes which House Democrats put back on the table as of the time of writing. For high-value investors, the impact will be especially significant.

While 401(k) and IRA changes for 2022 aren’t set in stone yet, it’s useful to plan ahead for what your retirement investing will look like if the new rules take effect. Here’s a quick review of some of the major changes still included in the bill as of the time of writing.

Limits on High-Income Earner Contributions

Under current IRA rules, an individual with earned income who does not participate in a 401(k) plan or similar qualified account and whose spouse also does not participate in such plans can contribute to an IRA, regardless of their income level or other retirement savings.

Under new language outlined by the Ways and Means Committee, the new bill would create new rules for taxpayers with very high IRA and defined contribution retirement account balances. The legislation prohibits additional Roth or traditional IRA contributions for the taxable year if an individual’s total balance between IRA and defined contribution accounts generally exceeds $10 million as of the end of the prior taxable year. This only applies to single taxpayers with taxable income above $400,000, married joint filers with taxable income over $450,000, and heads of household with taxable income over $425,000. Because Roth IRA contributions already limit contributions based on income, there would be no changes for Roths.

This is part of a larger Democratic outcry in response to a ProPublica report that Peter Thiel, a co-founder of PayPal, owns a Roth IRA that grew to $5 billion in 2019, up from less than $2,000 in 2019—essentially acting as a tax-free piggy bank. The idea is to avoid subsidizing retirement accounts once they reach very high balance levels.

RMDs for Mega IRAs

A required minimum distribution (RMD) is the minimum amount you must withdraw from your account each year. Under current law, these generally kick in around age 72 and are based on a uniform lifetime distribution number set by the IRA, which is essentially a life expectancy estimate, and based on the value of the account at the end of the previous taxable year.

Once again, individuals with combined traditional IRA, Roth IRA, and defined contribution accounts in excess of $10 million are under fire to avoid using their accounts as a tax-free haven. Those with accounts in excess of $10 million must withdraw at least 50% of the excess money the following year, while those with accounts in excess of $20 million must withdraw from their Roth IRA and 401(k) plans before they can withdraw from their traditional IRA. This would apply to individuals whose taxable income matches the contribution limits outlined above.

Again, the idea is to avoid giving high-net-worth individuals a free tax haven, reintroducing taxable income into the economy in order to fund major government programs.

End of Backdoor Roth Conversions

Are you sensing a theme yet? Lawmakers recognize that high-net-worth individuals tend to use their tax-free retirement accounts to stow away taxable income, and they want that money back in circulation. This is why backdoor Roth conversions are also on the chopping block.

A backdoor Roth IRA conversion is a way for taxpayers to convert a traditional IRA into a Roth, even if their income is too high to qualify for a Roth normally. And while savers will pay taxes on the conversion, their future growth and distributions grow tax-free.

The new legislation slams the door on that strategy by eliminating Roth conversions for traditional IRAs and 401(k)s. Again, it would apply to the same income brackets outlined in the previous section.

Mega Backdoor Roth

The bill isn’t friendly to high-value retirement accounts for high-net-worth individuals. And it’s even less friendly to backdoor Roths of any kind.

A mega backdoor Roth is a strategy that would allow high-earners to stow $38,500 into a Roth IRA or Roth 401(k) using the same basic principle as a backdoor Roth conversion. Basically, if you use a clever after-tax bucket to save more than $58,000 in a 401(k) plan (well above the standard contribution limit) you can boost your tax-free growth by converting the excess into a Roth.

The new legislation would prohibit all after-tax contributions in workplace plans, as well as prohibiting all after-tax IRA contributions from being converted into a Roth. This would apply regardless of your income level.

Accredited Investors

Broadly speaking, an accredited investor is someone with the means and financial sophistication to weather high-risk investments. Similarly, certain IRA investments require a minimum amount of asset value or income level to qualify, or a specific credential showing expertise in the investment.

The new law would disallow such investments, meaning that IRAs with such investments would lose their IRA status (and thus their tax-free benefits). There would be a two-year transition period allowing IRA owners to do away with such investments and keep their IRA status, but one way or another, the investments would not be eligible for holding in an IRA (meaning you can no longer use your IRA as a tax-free shelter for such investments).

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