A handful of words deep in President Barack Obama’s proposed
budget would put the kibosh on a pair of strategies that high earners can use
together to funnel large sums into Roth individual retirement accounts. The
president is looking to slam the door on the so-called back-door route
into Roth IRAs as well as to close off the ability to roll after-tax
contributions in a company 401(k) plan into a Roth IRA. The second strategy was
simplified by a 2014 ruling from the Internal Revenue Service.
The brief reference in the massive budget document—“Limit
Roth conversions to pre-tax dollars,” on page 121—was spotted by Jeffrey
Levine, a CPA and IRA technical consultant with Ed Slott & Co. in Rockville
Centre, N.Y. The Treasury Department’s explanation of the budget proposal
confirms Mr. Levine’s first impression: that it would end these two strategies
that depend on converting after-tax contributions that were made to a
conventional IRA or workplace retirement plan into a Roth.
The big appeal of Roth accounts is that they can grow with
no immediate tax hit—and no tax is due when money is withdrawn in retirement.
Direct contributions to Roths are made with after-tax dollars, and are subject
to both annual dollar limits and income caps. It’s possible to convert a
traditional IRA into a Roth. But that typically involves a big tax bill if the
traditional IRA was funded with pretax dollars, as they typically are.
In the back-door strategy, a high earner can make after-tax
contributions to a traditional IRA and then convert the IRA to a Roth—sidestepping
the income limits on contributing to a Roth. Similarly, making after-tax
contributions to a 401(k) plan is a way for an individual who is already
contributing the maximum salary deferral to the plan to put in additional
after-tax dollars and then move them into a Roth IRA upon retirement.
Separately, Mr. Levine notes that the budget proposal also
would eliminate a tax provision that can benefit people whose 401(k) accounts
include company stock that has gone up a lot in value. Under the current rules
for “net unrealized appreciation in employer securities,” there’s an option at
retirement to transfer those shares to a taxable brokerage account—which may
help lower taxes over time.
Loading up on company stock can be unwise, the budget
explanation notes, because financial problems at the company could affect the
value of the worker’s retirement account as well as his or her job security.
The president’s proposal would repeal the special option for distributions of
employer shares starting next year, but only for participants who are younger
than age 50 at the end of 2015.
To be sure, these proposals, like others in the president’s
budget, may go nowhere. But they signal increased attention to strategies that
have been useful in trimming taxes for some individuals.
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