Congress has set its sights on mega-IRA balances, in large part due to the recent reports about Peter Thiel’s $5 billion Roth IRA. But some of these proposals will impact many other clients with smaller individual retirement accounts and Roth IRAs.
Keep in mind that these are only proposals — the first salvos from Congress. The proposals may not become law or if they do become law, they may be changed from their current form. But clients are hearing about these proposals and want to hear from you as their advisers on potential proactive planning moves they might start setting in motion now to be better prepared.
First up are the provisions targeting super-sized IRAs, which are defined as those with balances exceeding $10 million. The proposal prohibits making additional contributions to IRAs and Roth IRAs for those who have total retirement account balances (the combined total of all IRAs, Roth IRAs, and company plan retirement accounts) in excess of $10 million, and whose income exceeds $400,000 for single individuals or $450,000 for married joint filers. Both conditions must apply.
This provision would be effective starting next year but will have almost zero impact on these clients. That’s because the maximum that can be contributed annually to IRAs and Roth IRAs is currently only $6,000 (or $7,000 if age 50 or older). These amounts don’t even show up as a blip for owners of mega RIAs. They are not even one-tenth of one percent of that $10 million, so this proposal really accomplishes nothing. Plus, the bill still allows contributions to company retirement plans where much larger contributions can be made regardless of income.
GIANT RMDs — REGARDLESS OF AGE
But the next provision can really make a dent in these mega-IRA balances. If the same two conditions apply (combined retirement balances exceed $10 million and income over the same $400,000/$450,000 limits), there would be a required minimum distribution of 50% of the amount that the combined retirement balance exceeds $10 million.
This would apply at any age, not just at age 72, when RMDs would apply under current rules. In case you were wondering whether the 10% early distribution penalty applies to RMDs for someone under age 59 ½ (like a Peter Thiel), the bill waives the 10% penalty on this RMD.
But now it gets worse — for those with $20 million or more in combined retirement savings (and over the income limits). The RMD would jump to a 100% RMD on combined balances in excess of $20 million, or the entire balance in both Roth IRAs and company Roth plans, if that amount is less. The RMDs would first have to come out of all Roth accounts (Roth IRAs and company plan Roths), and then from other retirement accounts, until the full RMD is satisfied. This is in addition to the 50% RMD above, based on a convoluted calculation that even most experts do not understand.
This provision is likely to apply to very few people, but any adviser who has one of these clients should get the word out now. For example, under these mega-RMD provisions, Peter Thiel (at whom they were aimed) would essentially have a $5 billion taxable RMD from his Roth IRA, because he is under age 59½ and, other than his original $2,000 Roth IRA contribution in 1999, it’s all earnings.
One way Thiel and others with these gigantic IRA balances might get around this is to keep their income under the $400,000/$450,000 limits. Wealthy clients who could be affected by these mega-RMDs should start planning now to keep income low, since this provision, if enacted, would be effective next year.
RIP BACK-DOOR ROTHS
Now to the provisions that will affect many more of your clients. The proposals include an all-out ban on back-door Roth IRAs and mega-back-door Roth IRAs (from company plans), regardless of income level, so this means everyone.
If you have clients who have been taking advantage of these provisions, especially the lucrative mega-back-door Roth, which can allow up to $58,000 this year to be contributed to after-tax plan accounts and converted to Roth IRAs, generally tax-free, this may their last chance. So make sure to have your clients get these done before year-end. The proposed ban would be effective after this year, like the other provisions mentioned above.
FUTURE ROTH CONVERSION LIMITATIONS
Congress also wants to eliminate Roth conversions from pre-tax funds for high earners (with incomes over the same $400,000/$450,000 limits), but this provision would not be effective for more than 10 years!
At first, the effective date on this provision (which is stated as beginning in years after Dec. 31, 2031) looked like a typo. But it has since been confirmed. While Congress says they want to rein in Roth conversions for higher earners, they are still desperate for the conversion revenue from this group to make the 10-year budget projections work. This shows you that Congress can’t really let go of Roth conversion income. They still need it to balance the books.
Your clients will have at least a decade on this, but since Congress has tipped its hand, start planning now, while tax rates are still relatively low, to have your higher income clients begin a series of annual Roth conversions while they can. This strategy will be especially effective to begin before they become subject to RMDs at age 72. Since RMDs can’t be converted, the conversion strategy will cost more once RMDs begin.
The overall strategy for these provisions is to begin lowering income and traditional IRA balances. Alert your clients who want to hear from you with planning ideas on these issues.
Hear more in this afternoon’s webinar: 2021 Year-End Planning Conversations with Ed Slott
Andrew is half-human, half-gamer. He’s also a science fiction author writing for BleeBot.