Biden’s budget targets backdoor Roths and $10M retirement accounts

The proposed budget seeks to increase taxes for corporations and the wealthy.

Wealthy Americans would lose some of the tax perks they can currently access through various retirement savings accounts under the budget proposed Monday by President Joe Biden.

Those cuts are part of a wider push by the White House to raise taxes or eliminate loopholes for corporations and very wealthy households, while proposing certain tax reductions for lower-income families.

On the cutting board is the so-called “backdoor” Roth IRA conversion, a strategy that’s used by high earners to get around the income limits on contributions to individual retirement accounts. The proposed budget, which includes many changes previously floated by the administration, would also tamp down on high account balances in various tax-deferred accounts.

“The provision would prohibit a rollover to a Roth IRA of an amount distributed from an account in an employer-sponsored eligible retirement plan that is not a designated Roth account (or of an amount distributed from an IRA other than a Roth IRA) for a high-income taxpayer,” an explanation of the budget by the Treasury Department read, defining high income as $450,000 for those married and filing jointly, $425,000 for the heads of households, and $400,000 in other cases.

Curiously, the Treasury’s “green book,” which explains the proposed budgetary provisions, does not mention 401(k) plans once in its 256 pages, although it does point to 401(a)s, 403(b)s, 457(b)s and simplified employer pension plans that would be subject to limits. However, that is likely not an oversight, as 401(k)s are a type of 401(a), said Mark Iwry, nonresident senior fellow at The Brookings Institution.

“Without a doubt, Treasury’s proposal applicable to retirement plans exceeding $10 million ‘to which section 401(a)’ applies is intended to cover 401(k)s,” Iwry, former senior advisor to the Treasury secretary for national retirement and health care policy, said in an email.

Biden would also prohibit Roth IRA rollovers “unless the distribution was from a designated Roth account within an employer-sponsored retirement plan or was from another Roth IRA if any part of the distribution includes a distribution of after-tax contributions.”

To reduce “excessive” balances in IRAs and other accounts, the administration also wants to impose distribution rules for high earners who amass more than $10 million. In such cases, account owners would have to take annual distributions of at least 50 percent of anything over that amount, with additional restrictions for accounts of more than $20 million, according to the Treasury.

The Treasury’s green book is 20 pages longer than that for the last proposed budget, but 90 percent of the proposals are the same as before, Richard Pon, a CPA and CFP, said in an email.

“The major change I saw is not related to retirement. It’s related to corporate compensation. Publicly traded companies are limited to a $1 million deduction on certain covered employees (such as CEO). This $1 million includes option income,” Pon said. “This year the proposal applies to all corporations (not just public) and all employees (not just to seven employees).”

NOT POPULAR WITH THE BENEFITS INDUSTRY

“Any changes that take away the ability to accumulate or participate [in retirement accounts] are not particularly popular within the benefits industry. That’s for sure,” said Craig Copeland, director of wealth benefits research at the Employee Benefit Research Institute.

The proposed retirement account changes would apply to people with high incomes, so not very many people would be affected directly, he said. However, some small businesses with highly compensated employees could be discouraged from offering plans, given proposed restrictions on the tax benefits they might otherwise get from providing them, he said.

“If the employer doesn’t offer the benefit, then people on the lower [end of the income] scale aren’t going to have the benefit,” Copeland said. Small business “is where the most impact would be.”

Editor’s note: This story was updated with comments from Mark Iwry clarifying the inclusion of 401(k)s in the proposed account limits.