End of Mega Backdoor Roth IRA Tax Loophole?!

The End of Mega Backdoor Roth IRA Tax Loophole?!

Potential tax changes in 2021 could mean the end of backdoor and mega backdoor Roth IRA conversions! I explain how this could affect everyday people who are trying to maximize their retirement savings! And what I call the Peter Thiel rules.

The blog post that accompanies this video aims to help us be as prepared as possible, no matter what tax changes are happening!

The proposed tax changes are aimed more so at those who bring in higher levels of income, such as $400,000 and above, but not all changes only affect “the rich and wealthy.”

It’s also important for people to know the difference between income and wealth. Income means the flow of money coming in, such as earned income from a job. Wealth is having savings or assets, it’s a store of money.

Being wealthy is not necessarily equal to bringing in a lot of income. Someone could be making $400K/year, but if there’s nothing to show for it in their savings, investments, or assets, then they may not be that wealthy.

But there’s a higher likelihood that those who are making a lot in a year tend to save and invest those cash flows. Many of the proposed changes are targeting tax loopholes for those whose incomes are high and who have been able to take advantage of these loopholes to date.

I explain some of the existing retirement investing accounts and how they could be affected by the proposed tax changes. These accounts include the Traditional Individual Retirement Account (IRA), Roth IRA, and 401k (both pre-tax and after-tax/Roth).

A lot of people can contribute to these types of accounts. Some who earn too much money get phased out of a Roth IRA. If you’re a single person under 50 making up to $124,000, you can contribute up to $6,000 to a Roth IRA or Traditional IRA. For 50+ there’s catch-up contributions for a total of $7,000 that can be contributed.

But if you’re phased out at making over $140,000, then you can only contribute $6,000 to a Traditional IRA but not the Roth IRA. However, as of 2021 you can do a backdoor Roth IRA conversion by just paying income taxes on what you roll over from the Traditional IRA to the Roth IRA.

The main appeal of doing any conversion to a Roth IRA is that you could grow your investments tax-free and you would not have any required minimum distributions (RMD). It’s been relatively easy to convert from an IRA into a Roth IRA to date, but this is all about to potentially change in a massive way.

For the 401k in 2021: If you’re under 50, you can contribute up to 19,500, and those who are 50+ can contribute $26,000. And the only salary limit to contributing to a 401k is $290,000.

Then your employer could contribute up to $38,500 to the 401k, with the total being either $58,000 or $64,500 if you’re below or above age 50.

If you contribute after-tax money to a Roth 401k, then you’ve been able to roll these funds into a Roth IRA in what is called a mega backdoor Roth IRA. This gives you the most you can roll over into the Roth and grow it tax-free forever.

To me, it’s the biggest deal of all that the ability to convert the after-tax Roth 401k into a Roth IRA could be taken away by 2022 because the proposed rules from the House Committee on Ways & Means say:

“Furthermore, this section prohibits all employee after-tax contributions in qualified plans and prohibits after-tax IRA contributions from being converted to Roth regardless of income level, effective for distributions, transfers, and contributions made after December 31, 2021.”

This means that some people may want to finish doing any Roth conversions before a potential deadline of December 31, 2021 because some retirement accounts may be turning into pumpkins by 2022 as some retirement strategies get limited.

In order to afford the government’s $3.5 trillion budget plan, other proposed changes include: increased corporate tax rates and higher capital gains taxes at 28.8% for certain income levels.

There are a few potential rules that will mostly affect those with incomes above $400,000 and I cite the rules from the original House Committee on Ways & Means source.

If you’re among the top 1.8% who make over $400,000, after December 31, 2031 (yes 10 years from now), you wouldn’t be able to do any more backdoor Roth IRA conversions with nondeductible (after-tax) contributions from either IRAs or 401ks (employer-sponsored plans).

This might be wishful thinking on my part, but maybe we can still contribute pre-tax money to these accounts, and maybe still convert them into Roth versions? And another source suggested we could still roll over a Roth 401k to Roth IRA, but I’m not holding my breath as to if that could be remain true.

Worst case scenario our funds remain stuck in a 401k or IRA respectively, and then live with required minimum distributions when we’re in our older retirement years.

After 12/31/21, the proposed rules would prohibit those making over $400,000 from further contributing to any IRAs if the total value across IRAs and 401ks exceeds $10 million.

“Peter Thiel Rule Part 1” is what I nickname the proposed rule of having values across all IRAs and 401ks be $20 million, then the excess is required to be distributed after 12/31/21.

Peter Thiel had grown his Roth IRA from something like $2,000 to over $5 billion from his founder shares in PayPal. This is part of why these proposed changes are coming into the fore. But not everyone had founder shares like Peter Thiel, Berkshire Hathaway investor Ted Weschler has $264 million in his Roth IRA where his investments since 1984 simply compounded over time.

“Peter Thiel Rule Part 2” is what I nickname the proposed rule of accredited investors would not be able to keep any securities in an IRA after 12/31/21.

If you don’t want Uncle Sam to slam the tax door in your face, if you’ve made after-tax contributions in an IRA or 401k, you might want to move that over into a Roth IRA in 2021 so it remains as tax-advantaged as possible. But not everyone can move funds out of a 401k if you’re still working for the same employer.

So thems the breaks if we might have to say goodbye to some of the backdoor possibilities for good.

However, during the current session of Congress in 2021, these rules would have to be approved first in the House, then in the Senate, and finally it would be signed by the President. So lets see what shakes out.

If you’re interested in learning how to take control of your finances and start becoming an investor like Warren Buffett, check out my free PDF guide.

I look forward to making more investor friends! Add me on Instagram: michellemarki