Roth IRAs remain attractive planning tools despite recent bills

The Roth IRA is a popular and often effective tax and retirement savings tool for a wide range of taxpayers. Not only is it an investment vehicle that can be taken out of tax exemption, subject to certain requirements, but it can also be used as a wealth transfer vehicle for high net worth and ultra high net worth individuals. -high net worth individuals seeking to manage their income and subject to income tax both during their retirement years and for their beneficiaries.

Personal income tax brackets and top marginal tax rate are set to increase after December 31, 2025, with the sunsetting of individual provisions of the Tax Cuts and Jobs Act 2017 , the recent changes made by the law on the establishment of each community for the improvement of the retirement of 2019 (SECURE Law), and the prospect of further legislative changes on the horizon. This article will focus on recent and proposed legislative changes, as well as the potential impact on current and future account holders and beneficiaries.

Brief overview

At a high level, a Roth IRA is an individual retirement plan that allows taxpayers to contribute after-tax dollars, subject to income limits and contribution limits. For 2022, the ability to contribute to a Roth IRA is being phased out at a modified adjusted gross income of $144,000 for single taxpayers (plus head of household, filing married separately, and taxpayer living separately from spouse at any time). time of year). ) and $214,000 for a married joint filing.

Aggregate contribution limits of $6,000 for taxpayers under 50, with an additional $1,000 catch-up for taxpayers over 50, also apply. There is a five-year holding period requirement before an account holder can withdraw money tax-free. Also note that these Roth IRA withdrawals are not subject to the required minimum distributions after the taxpayer reaches 59 1/2.

Changes under the SECURE Act

The SECURE Act, signed into law in December 2021 as part of the Supplemental Consolidated Credits Act of 2020, has impacted how traditional IRAs and Roth IRAs are viewed from both a wealth transfer perspective and tax planning.

Prior to the SECURE Act, beneficiaries of inherited IRAs could benefit from what is often referred to as “stretching,” a planning strategy that provided for the extension of the tax-deferred benefits of an IRA to a non-joint beneficiary with the minimum required distributions. (RMD) generally based on the life expectancy of the beneficiary, as opposed to the life expectancy of the original account holder.

While the legislation was generally taxpayer-friendly and a discussion of all of the changes enacted under the SECURE Act is beyond the scope of this article, under a new provision of the SECURE Act, the “extension” for Inherited IRAs have been eliminated unless the beneficiary is an “eligible designated beneficiary”. As a result, non-spouse beneficiaries generally must liquidate the IRA within 10 years of the participant’s death.

Additionally, under the proposed settlement issued on February 24, 2022 (REG-105954-20), annual distributions must continue if the account holder was required to take RMDs prior to their death. These significant changes may create unintended tax consequences from a wealth transfer perspective, particularly for taxpayers with pension assets payable to trusts. The language typically included in these trusts may result in retirement assets being paid out to beneficiaries sooner than expected, subjecting the assets to creditors, divorced spouses, etc. It is prudent for a taxpayer with retirement assets to have their estate plan reviewed in light of this and other changes under the SECURE Act.

So what does this mean for Roth accounts? Although Roth IRAs are also subject to the 10-year liquidation period requirement under the SECURE Act, the Roth IRA is not subject to the RMD requirement, allowing beneficiaries to wait until the 10th year to liquidate the account, tax-free. The seismic change of “death of stretching” under the 10-year rule, coupled with the prospect of future higher individual tax rates, may make the Roth IRA a more attractive option for taxpayers, and it is prudent to explore or revisit discussions of Roth conversions in light of these recent changes.

Proposed legislative changes

Ongoing discussions of SECURE Act 2.0 legislation, with three proposed bills being discussed in Washington, include several topics that would expand upon the original SECURE Act. The proposed legislation would allow employers to make a company contribution to an employee’s Roth account, helping to grow employee accounts tax-free.

Although removed from the final version of the legislation enacted as part of the budget reconciliation process on August 16, 2022, the preliminary proposals included in the House-approved version of the Build Back Better Act would have significantly reduced Roth’s planning by three ways:

  • First, the bill would have prohibited new contributions to Roth IRAs for any tax year where the contributions would cause the total value of the individual’s IRA and defined contribution retirement accounts at the end of the previous taxation year exceeds (or exceeds more) $10. million. The limit would have applied to married taxpayers filing jointly with income over $450,000, heads of households over $425,000, and single and married filers filing separately over $400,000.
  • Second, if the combined balances of an individual’s traditional IRA, Roth IRA, and defined contribution retirement account typically exceed $10 million at the end of the tax year, and the individual meets the above thresholds, the invoice included a minimum distribution requirement in the following tax year. .
  • Third, the bill would have prohibited the conversion of all after-tax employee contributions to qualified plans and after-tax IRA contributions to a Roth IRA, regardless of income level.

This proposal would have effectively ended what is informally known as Roth Stepping. While these proposals did not pass, there appears to be support for placing guardrails on Roth “mega” planning which has been fueled in part by the recent widely publicized strategy talks. While the likelihood of these or other proposed changes to Roth IRAs depends heavily on the political make-up of Congress and the White House, it is often the case that today’s proposed legislation has the potential to be incorporated into future legislation.

Conclusion

The Roth IRA can be used in several ways to promote tax-free growth for account holders and future beneficiaries. Even under current and proposed legislation, the Roth IRA often remains a flexible and effective planning tool for taxpayers of all tax brackets and income levels, which can provide powerful planning opportunities for account holders.

This article does not necessarily reflect the views of the Bureau of National Affairs, Inc., publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Andre Sageser is senior tax manager at FORVIS. He has over 10 years of public accounting and tax experience, specializing in a variety of tax and advisory services focused on the needs of private businesses and their owners, as well as high net worth individuals, flow-through entities, gifts, trusts and estates.

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