Farewell to a Friend, Act 2 – House Votes to Eliminate ‘Backdoor’ Roth IRAs

Farewell to a Friend, Act 2 – House Votes to Eliminate ‘Backdoor’ Roth IRAs

I wrote a few weeks ago that Congress was preparing to limit the use of Roth IRA accounts, particularly for wealthier taxpayers.

I wasn’t entirely sure of their motives, but now all ponderings are moot.

On 19 November, the House of Representatives passed its version of President Joe Biden’s ‘Build Back Better’ plan, and among its near-limitless provisions lie new rules that will scotch the so-called ‘backdoor’ and ‘mega-backdoor’ Roth IRA strategies.

The ‘backdoors’ have never been widely available or taken up by retirement savers, though more providers have been offering the strategy of late. Yet a recent Congressional kerfuffle arose after media revealed that billionaires were using – read abusing – these ‘backdoor’ retirement schemes.

The definitory case involved Peter Thiel, founder of PayPal. Reports say his Roth IRA held $5 billion, yet it started with only $2,000. Wily old Pete had contributed shares in a privately owned company to his Roth IRA; when it went public, the valueless stock launched stratospheric, tax free.

Congress, which wrote the applicable laws, professed shock this could happen. That’s simply because, in terms of percentages, it never does.

This narrative stinks. The very idea that one garish case, an outlier of a few billionth proportions, sprayed virtual WD-40 onto Congress’s frozen legislative drivetrain, leading suddenly, nee immediately, into a flurry of lawmaking sounds pretty darn silly. Get Jimmy Stewart’s spirit to star in this roiling potboiler and I still wouldn’t buy a ticket.

No – this isn’t ‘Mr. Smith Goes to Washington’. This scenario recalls ‘Casablanca’ and Captain Renault, the corrupt Vichy sûreté officer who shuts down Rick’s Café Américain, announcing he is “shocked, shocked” to discover gambling on the premises, as the pit boss oils up and hands him his winnings. Renault unctuously thanks him, displaying grace you won’t find on Capitol Hill – but he still shuts Rick down. Thiel may lack Bogart’s gray-pallet gravitas, but he still gets the part in the remake.

I don’t like this innocent act in DC, see. I like it even less when I can’t figure the angles. What were those Congressional banana-heads up to, with their contrived sanctimonious podium thumping? Writing a legislative proposal takes months, there’s a system – yet they did it on spin cycle. What gives?

Well, I suppose it was a setup. They just wanted the taxes, the ‘winnings’ all profligate politicos covet, whatever the party or faction. Maybe I’m rough, too hardboiled by half, but they won’t be the ones taking a smack to the kisser.

The Roth IRA is beloved of Congress, a shining example of cross-aisle collaboration for the good of all Americans. But some of its provisions, used at first by few taxpayers but rising in interest, limited taxes too well by half. Renault made a good living off the Café Americain; then the hot desert wind scorched the old world and blew all away. Far from deserts and dreamland, the backdoor is closing, dear customers. It’s the end of a beautiful friendship.

Coming soon to our screens: the House bill faces reconciliation with the Senate version. As I go to press – copy, boy! – that hasn’t seen light of day. The upper house is split fifty-fifty and in the event of a tie (bet on it) the deciding vote goes to its inflexible president, VP Kamala Harris. Last-minute talks will be fraught and plenty can go wrong, but the huffing senatorial steam engine – “I think I can, if my right honorable colleague will cease bloviating” – has seen the dark tunnel lighten. If the House can do it, anyone can. I expect a final bill shortly.

So let’s list the damage, if it all comes to pass as now written. First, all backdoor Roth conversions would be banned from the end of this year, period.

Next, starting in 2029, taxpayers entangled in those $400k limits would be prohibited from contributing to IRA accounts if their aggregate balance tops $10 million.

A double-stinger would hit these wealthier savers: if their retirement account balances overstep the ten-mil boundary, a ‘special’ RMD would be required the next year, potentially leading to an eyewatering tax bill. Well, after all, that is the government’s intention.

Standard Roth conversions are still legal under the bill, but income limitations on participation will go live in 2032. Those $400k boundaries will apply: the usual suspects would be prohibited from converting any retirement accounts funded by pretax money into Roth accounts.

House Democrats originally wanted to ban IRAs from holding unregistered securities, particularly the kind of private equity that led to Thiel’s scandal. They dropped this demand, gave up something to get more, I reckon. Rate it a small victory for the sophisticated retirement savers to which it applies.

Since backdoor Roth strategies are out with the Dodo, here’s what to do next: sit down with your retirement planners and run your eye over alternatives. Consider the benefits of health savings accounts. HSAs offer tax-free appreciation of pretax contributions. They can fund qualified medical costs at any age. After retirement, withdrawals can be made for nearly any kind of expense, though the funds will be taxable, similarly to a 401(k).

All is not lost, not even by half. Rick will always have Paris; we will always have retirement planners, their teams stacked with swatting sultans of investment, taxes, and life insurance. They’re ready to fight off whatever a legislature or well-funded tax man (the House bill adds $80 billion to IRS enforcement) can pitch to us. Here’s looking to them, kids.

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