President Biden signed the Inflation Reduction Act into law in August 2022. This is a trimmed-down version of the Build Back Better Act, a $1.75 trillion social spending initiative that had struggled to get votes in Congress. The expanded bill initially proposed ending a lucrative retirement account loophole known as a backdoor Roth IRA, which benefits high-income earners. Here’s what you need to know.
Whether you have a traditional or a Roth IRA, you may want to work with a financial advisor on how best to handle such accounts to maximize your retirement assets.
What Is a Backdoor Roth IRA?
A backdoor Roth IRA, which came into effect in 2010, permits account holders to work around income tax limits by converting what was originally a traditional IRA into a Roth IRA. For people with a modified adjusted gross income above certain levels, there are limits on direct Roth IRA contributions. Under current tax law, individuals making more than $153,000 in tax year 2023 (up from $144,000 in 2022) are barred from contributing to a Roth IRA, where retirement savings grow tax-free.
However, workers who exceed this income threshold have been permitted to convert their pre-tax contributions into a Roth IRA. After they pay income taxes on the initial contributions and gains, their retirement savings grow tax-free and are no longer subject to required minimum distributions (RMDs).
The Once-and-Future Loophole
Democrats on the House Ways and Means Committee initially proposed eliminating the backdoor Roth IRA strategy to help pay for Biden’s Build Back Better bill, which was worth then $3.5 trillion. But after moderate Democrats, and Republican lawmakers, opposed the high cost of the bill, a scaled-back proposal trimmed down the new draft of the legislation to $1.75 trillion.
One such feature was the proposal to eliminate the backdoor Roth IRA strategy. Before being removed from Build Back Better, the bill would have stopped Roth conversions for both IRAs and employer-sponsored plans for single taxpayers and married taxpayers filing separately with taxable income greater than $400,000, married taxpayers filing jointly with taxable income above $450,000 and heads of household with taxable income over $425,000. The elimination of the backdoor Roth IRA would have taken effect after Dec. 31, 2021.
House Democrats ultimately approved the Inflation Reduction Act in August 2022, which is worth less than a quarter of $3.5 trillion Build Back Better Act ($740 billion). Lawmakers left out some proposals that had been initially proposed as part of a plan to help pay for the legislation. One of those proposals excluded was eliminating the backdoor Roth IRA.
With the now 12-year-old loophole off the chopping block, the pressure many taxpayers planning for retirement were feeling to take advantage of it is gone. This means that if you are ineligible to put money into a Roth IRA, you can still do so into a traditional IRA and then convert that money into a Roth so that it can grow tax-free.
Retirement Planning Tips
- A financial advisor can help you decide if rolling over a 401(k) or executing a Roth IRA conversion fits into your financial plan. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Will you have enough money to retire comfortably? SmartAsset’s free 401(k) Calculator can help you determine whether you’re on track to retire on time.
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