A few weeks back, we were sipping our sparkling wine with the estate planning crew, celebrating a minor victory.
Congressional Democrats had scrapped plans to eliminate the step-up in basis, a small win on the tax front.
That saved us a heap of trouble, yet it cost the tax-raising party in Congress a bundle. We knew they would adjust; now we know how.
The House Ways & Means Committee has released its recommendations for piling up $2.1 trillion in new tax revenue, to help fund President Joe Biden’s spending plans. Is that a lot of money? They say a stack of one-dollar bills laid two-trillion high would reach halfway to the moon – well, not so impressive. And who carries ones these days, anyway?
I will concentrate on the proposed changes to retirement planning. This isn’t our first time through the Biden tax wringer, so we’d best focus on the new proposals, which have popped up like cheap Halloween skeletons – just on time for the second-scariest day of the year, after April 15.
Congressional Democrats say ultra-wealthy Americans are using popular retirement plans like the IRA, 401(k) and their permutations as tax shelters. This was never the intent, they say: those retirement plans were invented so middle-class workers could build up their nest eggs.
Reportedly – words that inspire little confidence today – there was an ‘outcry’ following reports that Peter Thiel, a founder of PayPal, had $5 billion in his Roth IRA – Congress had to respond. True scary story: in 1999, Pete’s account held only $2,000. The ghost of the American dream turned corporeal – leap up in terror, Democrats!
To be fair, if Nancy Pelosi were here, she’d probably say: it’s the tax-dodging that’s creeping us out. Then, she’d give me a backhander, I bet. There are two sides to every horror story.
Yet I don’t quite buy it – the story sounds like cooked-up convenience food. Complex proposals don’t leap up like the Great Pumpkin; they take sharp carving, for good or ill. No; this is just politics, an excuse to make ends meet, no mean feat when you dream in the trillions.
Let’s do what we do and break it all down.
The new spine-tingling stuff starts in Part 3, Subpart A of the Ways & Means report, titled Limitations on High-Income Taxpayers with Large Retirement Account Balances. Sounds like macabre reading from the outset.
New rules: wealthy savers won’t be allowed to contribute to a Roth or traditional IRA if the combined value of their defined contribution plans exceeded $10 million in the prior taxable year. This only applies to single individuals with more than $400,000 per year in taxable income (married joint filers: $450k; heads of households: $420k), indexed to inflation. Keep those income limits in your heads as they are broadly applied.
Next, employers face a new reporting requirement: if the aggregate balance of a retirement plan holder’s accounts exceeds $2.5 million, it must be reported to the plan participant – and the IRS. The taxman is getting an extra $80 billion to fund enforcement, remember? And so, it begins.
The required minimum distribution (RMD) for bulky retirement holdings will rise. If the combined balance of a retirement investor’s IRA, Roth IRA, 401(k) and other defined plans exceeds $10 million at the end of a taxable year, and that person’s taxable income outstrips the thresholds, the RMD would be 50% of any sum beyond the ten-mil limit.
Gosh, that’s a mouthful; let’s consider it tersely. Imagine the size of Peter Thiel’s first RMD in 2022, and the near-40% tax rate in waiting. Boo, Peter, boo!
Wait – just one more thing. It gets worse for Pete: if your combined balance exceeds $20 million, there’s a 100% distribution rule. The RMD must reduce the balance to the twenty-mil limit, with the funds taken first from Roth IRA or 401(k) accounts – yes, the ones with the best tax benefits.
Next: if you make more than $400k per year, “back-door” Roth IRA conversions will be off limits. Today, this strategy allows wealthy investors, with incomes too high to pay straight into a Roth IRA, to make after-tax contributions to a traditional IRA or 401(k), then convert it to a Roth IRA. This is the strategy that got Peter Thiel into such trouble.
The “mega-backdoor Roth” (where you can contribute up to $58,000 in after-tax money to a 401(k), roll it into an IRA, then eventually convert it into a Roth IRA for the tax advantages) would be banned for everyone, irrespective of income.
Democrats don’t like these strategies for many reasons, but one trick, quite legal, used by the super-wealthy, really hots-up their ire. Privately held stock can be included in a Roth IRA. If the company launches an IPO, those shares can be sold – likely at a greatly appreciated value – and the rich proceeds would remain in the Roth IRA, tax free. That’s the simplified gist of it, and Congressional Democrats want an end to it.
Finally, the bill would prohibit IRAs from holding securities if the issuer requires a minimum level of assets, income, education or a license, like a registered investor credential. IRAs containing such investments (usually unregulated by federal securities law) would lose their status – that is, their tax benefits. If this clause becomes law, it will go live on January 1, 2022, with a two-year transition period to amend any IRAs holding such investments.
If you have sympathy for the rich, please bow; if not, dance as dark shadows fall. I won’t spare concern for the mad ultra-rich, the billionaires: the changes, though galling, won’t really harm them. They’ll be just fine, the gilded bums.
The moderately wealthy, alas – I know them, and what they’ll soon face: deferred dreams, undone plans, hopes fouled on rocks. Beyond a young age, no one wants sympathy. Yet empathy is welcome and here easily arises. For what it’s worth, I greet you, my vilified posh mates. Welcome back to Earth.