Benjamin Franklin once said, “When you are finished changing, you are finished.” Another way to say this is, “The only constant in life is change”, according to Heraclitus, a Greek philosopher. And as a dad to three young ladies, I try to teach them that change is inevitable, growth is optional. Yes, I do get that teenager eye-roll every time I say it.
But you know, this concept certainly applies today in many areas of our lives, and our finances are no exception. The financial services world is continually shifting and evolving, and strategies that once worked well are no longer appropriate for – or in some cases available to – today’s retiree. Take the 4% rule, for example. This once-revered rule said that one could comfortably take 4% out of a portfolio each year (adjusted for inflation) and make your money last for 30 years. However, this theory has been debunked in today’s economic environment. Higher inflation, lower interest rates and the state of the markets at the time of your retirement can make the 4% obsolete today.
Changes in laws are also a key consideration, as they can change at any time and have a dramatic effect on our retirement plans. A perfect example of this is the “Backdoor Roth IRA”, which I discussed earlier this month. I had just met with a couple in their mid-50’s, I referred to them as Tom and Sarah, about the feasibility of using this strategy in their retirement system. Because of their income, they didn’t qualify to contribute to a Roth IRA, but are currently able to utilize this strategy to transfer the significant assets in their company retirement plans to a traditional IRA, and then convert it to a Roth. The funds in the Roth can then be accessed tax-free and are also free from Requirement Minimum Distributions (RMDs).
But in the blink of an eye, this is changing. In fact, just last week the House Democrats proposed a slew of changes to retirement accounts, part of a restructuring of the tax code tied to a $3.5 trillion budget plan. Taken together, Democrats’ reforms aim to erode the use of retirement accounts as a perceived tax shelter for the wealthy and instead promote them as a way for low- and middle-income Americans to build a nest egg. The proposed crackdown comes as the retirement accounts of the wealthiest Americans continue to swell. According to the Government Accountability Office, 9,000 taxpayers had at least $5 million saved in IRAs in 2011. Eight years later, that number had more than tripled to over 28,000, data from the Joint Committee on Taxation shows₁.
For example, let’s look at the Roth IRA conversion. There are income limits to contribute to Roth IRAs. In 2021, single taxpayers can’t add money to such accounts if their income exceeds $140,000. This bill would repeal so-called Roth conversions in individual retirement accounts and 401(k)-type plans for those making more than $400,000 a year. It would also prevent savers from using the “mega-backdoor Roth” strategy, regardless of income level. Further, the legislation would prohibit individual retirement accounts from holding investments that require buyers to be accredited investors, a status generally reserved for wealthy investors
The proposals are part of a broader theme of raising taxes on those who earn more than $400,000 a year to help pay for education, climate, paid-leave, child-care and other measures while also making the tax code be perceived as more equitable.
According to Sen Ron. Wyden D-Ore., “IRAs were designed to provide retirement security to middle-class families, not allow the super wealthy to avoid paying taxes,” he said in July after a data release showing growth of “mega” IRAs. Democrats have narrow margins within which to pass a bill, which they aim to do with a simple majority via a budget reconciliation maneuver.
Current law lets taxpayers make IRA contributions regardless of account size. However, the proposed legislation would prohibit individuals from making more contributions to a Roth IRA or traditional IRA if the total value of their combined IRA and defined-contribution plan exceeds $10 million. The policy’s purpose would be “to avoid subsidizing retirement savings once account balances reach very high levels,” according to a proposal outline. That limit would apply to single taxpayers with more than $400,000 of taxable income. The threshold would be $450,000 for married taxpayers filing jointly and $425,000 for heads of household.
In addition, individuals whose combined traditional IRA, Roth IRA and defined-contribution retirement accounts exceed $10 million at year’s end would have to withdraw at least 50% of the excess the following year. Those with account totals exceeding $20 million must pull from Roth IRAs and 401(k) plans first. These new required minimum distributions for mega IRAs would only be required for those whose taxable income exceeds the same thresholds identified above for the contribution limits.
The so-called “mega-backdoor Roth” strategy uses a principle similar to that of the backdoor Roth. The strategy lets high earners save up to $58,000 in a 401(k) plan — more than the traditional $19,500 contribution limit — using a type of after-tax 401(k) bucket. You then convert that savings to a Roth account, yielding the benefit of tax-free growth. Democrats’ legislation would end the mega-backdoor Roth by prohibiting all after-tax contributions in workplace plans and prohibiting after-tax IRA contributions from being converted to a Roth account. This policy would apply for everyone, regardless of income level.
These changes all point to a crucial component of retirement planning – that your retirement system is not a once-and-done task. It requires regular attention to keep up with changing markets, life changes, and new laws that affect your money. If you haven’t brushed off your retirement plan for a while, do it now. These pending changes could very well dictate changes to your approach, so work with your retirement specialist to make sure your plan is still relevant!
And as always – be vigilant and stay alert, because you deserve more!
Have a great week.
Jeff Cutter, CPA/PFS is President of Cutter Financial Group, LLC, an SEC Registered Investment Advisor with offices in Falmouth, Duxbury, and Mansfield, MA. Insurance offered through its affiliate, CutterInsure, Inc. We do not offer tax or legal advice. Jeff can be reached at jeff@cutterfinancialgroup.com.
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