Introduction
Today, the challenge for seniors preparing for retirement does not stop with securing enough funds for a joyful and healthy lifestyle. Nor does it stop with financing anticipated healthcare expenses like long-term care. In addition to these tasks, seniors must also cope with changing financial regulations—making retirement savings goals seem like moving targets.
Recently, there has been news about proposed tax legislation causing concern among seniors planning for retirement. The legislation, referred to as the Build Back Better plan, could dramatically affect seniors’ retirement accounts. To help seniors understand the implications this guide includes a snapshot of the proposed changes, a summary of who could be affected, and the impact on IRAs and other retirement plans.
Proposed Tax Changes
Though this tax reform bill is still making its way through Congress, it is nevertheless helpful to take time to understand its potential impact. No one wants to be blindsided by increased tax obligations and find themselves lacking the pension funds and personal savings to cover the cost. Early awareness helps seniors stay ahead of changes, so they can make any necessary adjustments to their savings strategies and retirement accounts.
The tax changes included in the 2022 budget proposal primarily impact the highest-earning households in the US through two taxes: the income tax and capital gains tax. For individuals with an income of $400,000 or higher and married couples with a joint income of $450,000 or more, the proposed income tax plan increases the top income tax rate from 37% to 39.6%. Though this income bracket comprises a mere 1.8% of the population, the 2.6% tax hike could raise hundreds of billions of dollars in revenue.
In addition to increasing the top income tax rate, the bill also proposes an increase in the capital gains tax rate. Under the new legislation, the top capital gains rate would rise from 20% to 25%. Those with incomes greater than $1,000,000 would have their capital gains taxed as ordinary income, typically taxed at a much higher rate than capital gains. These capital gains would only be taxed when the owner transfers their assets.
Fortunately for most seniors, these tax reforms do not aim to increase taxes for most Americans but instead attempt to increase tax revenue from the very wealthy. However, this does not mean the rest of the proposal doesn’t touch other population segments. For this reason, seniors must take a close look at the bill to see if they could be one of those impacted.
Who Could Be Affected By these Tax Changes?
The potential effects of the proposed tax changes go beyond the yearly income impacts noted above. In fact, the 2022 budget proposal may affect anyone who possesses the following qualifications:
- Adjusted gross income of at least $400,000
- Over $10 million in anticipated modified adjusted gross income
- IRAs or employer-provided retirement plans
- Ownership of a limited partnership or “S” corporation
- Current or planned trusts
- Itemized deductions on your federal tax return
As you can see from the above criteria, the proposed tax bill could affect very wealthy seniors and middle-class Americans with retirement savings invested in an IRA or retirement plan. All seniors facing these potential changes should research how their retirement planning could be affected in addition to any action they should take to protect their financial interests.
Impact on Retirement Plans
Seniors are likely most interested in determining how the pending tax changes would affect them no matter which stage of retirement they are in—early planning stages or well into their retired years. Though the proposed tax changes are not expressly aimed at affecting retirement savings, they could still have widespread implications for retirement planning. For those using a 401(k), traditional IRA, Roth IRA, or defined contribution account to save for retirement, read on to see how the tax bill would affect those retirement funds.
IRA Contribution Limits for High-Income Earners
As the law stands, IRA contributions are not limited by the owner’s existing account funds. However, under the pending Build Back Better bill, IRA contributions would be limited for very affluent taxpayers who have already contributed significantly to this account. Those whose combined balances in Roth IRA, traditional IRA, and defined contribution accounts exceed $10 million would not be allowed to contribute further to the account if their income passes a certain threshold. The annual cutoff income for each taxpayer depends on the individual’s filing status:
- Single taxpayers: over $400,000 annual income
- Heads of household: over $425,000 annual income
- Married taxpayers filing jointly: over $450,000 annual income
“Back-Door” IRA Loopholes
Currently, contributions to Roth IRAs come with income limits which prevent those with incomes beyond a certain level from contributing. For example, if your income was greater than $140,000 in 2021, you were not allowed to contribute. However, a loophole currently exists in the system which allows contributions to a Roth IRA, regardless of the contributor’s income, using a conversion. Through this “back-door,” high-income individuals can make a nondeductible contribution to a traditional IRA then quickly transfer the sum to a Roth IRA. From there, the funds could grow and later be distributed free of taxes.
The new tax bill aims to close these loopholes by putting an end to Roth IRA conversions for high-income taxpayers and those with employee-sponsored plans. If passed, employees at every income level would be prohibited from converting after-tax contributions to employer-sponsored plans into Roth IRAs. The bill would also prohibits Roth conversions for individuals who meet the following income limits:
- Single taxpayers: over $400,000 annual income
- Heads of household: over $425,000 annual income
- Married taxpayers filing jointly: over $450,000 annual income
Minimum Distribution Requirements
Minimum distribution requirements dictate how much seniors must withdraw from their traditional IRA or other retirement accounts each year. The new bill would increase the minimum distribution requirement for the highest-earning taxpayers. Specifically, this would affect people with more than $10 million in their combined traditional IRA, Roth IRA, and defined contribution retirement accounts with income in any of the following categories:
- Single taxpayers: over $400,000 annual income
- Heads of household: over $425,000 annual income
- Married taxpayers filing jointly: over $450,000 annual income
At the end of the tax year, the affected seniors would have to withdraw 50% of their aggregate account balance that surpasses $10 million. For those with combined retirement account balances greater than $20 million, the bill says they have to redistribute the sum greater than $20 million from Roth IRAs and Roth designated accounts in defined contribution plans. From there, they can choose from which accounts (traditional IRA, Roth IRA, or defined contribution retirement accounts) to distribute funds to meet the 50% distribution rule for savings over $10 million.
Accredited IRA Investments
The proposed plan eliminates the ability to include investments such as hedge funds and private equity in IRAs designated for accredited investors: those with some special credentials, minimum level of education, or income.
While the proposed bill aims to raise tax revenue from high-income taxpayers and close loopholes for their sheltering tax-free funds, this provision could potentially impact those with incomes less than $400,000. According to the definition of an accredited investor, which includes those making below $400,000 a year, the bill could limit the middle class from investing unconventional assets in IRAs. The impact of such a provision could potentially touch more than two million people planning for retirement in addition to those who surpass the $400,000 income limit.
Key Takeaways:
Under the proposed tax reform, high-income taxpayers would be subject to limits on their IRA contributions and contributions to other retirement savings accounts.
- The bill would eliminate the “back-door” Roth IRA loophole by restricting Roth IRA conversions
- The 2022 budget proposal increases the top income tax rate and capital gains tax rate for wealthy taxpayers.
- Minimum distribution requirements for traditional IRAs, Roth IRAs, and defined contribution retirement accounts would increase under the proposed tax changes.
- The Build Back Better agenda includes important considerations for all seniors planning for retirement, not just high-income earners.
Conclusion
Planning for retirement is crucial—especially in the light of these proposed tax changes. While new tax laws may add temporary stress to the planning process, early preparation and thorough research of their savings options can help seniors attain financial flexibility and enjoy a relaxing retirement.
We encourage seniors to consult with a financial advisor who can navigate through the potential impact of this bill on their household income and savings. Consulting with a professional can help seniors understand complex legal regulations and uncover their financing options—from reverse mortgages to life settlements. If a senior is unsure of their ability to fund a comfortable retirement, the sale of a life insurance policy through a Life Settlement provides a generous income supplement to pay for long-term care, retirement expenses, or any other pressing cost.
Ready to plan your next steps forward? The experts at Retirement Genius can help you unpack the specific implications of the proposed tax changes for your situation and start preparing for retirement. Contact us today to learn more about your savings options, long-term care considerations, and more.
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*Retirement Genius does not offer tax or legal advice. This material has been prepared for informational purposes only and should not be relied upon for tax or legal advice. Retirement Genius strongly urges you to consult with your own tax or legal advisors before entering into any transaction.
