Blog Misc Roth IRA Conversion Rules 2022: Here’s What It Means for You

Roth IRA Conversion Rules 2022: Here’s What It Means for You

date December 7, 2021 time 5 min read 8882 views

Recently, the U.S. House of Representatives has passed the Build Back Better bill that would limit some of the ways to accrue tax-free savings in the future. Do Roth IRA conversion rules impact your financial freedom plan? Let’s jump in.

The rich are currently prohibited from contributing directly to a Roth IRA if their modified adjusted gross income (MAGI) reaches at least $144,000 for individuals and $214,000 for the married. So a Roth IRA Conversion is used as a “backdoor Roth IRA”.

Congress wants to end the “backdoor Roth conversions”, so what does this mean?
Congress wants to end the “backdoor Roth conversions”, so what does this mean? (Source:Pixabay)

However, the draft bill approved by the House last November makes many people, especially high-income savers confused as it focuses on limiting tax-avoidance strategies favored by the rich. 

One thing savers usually look out for is the ever-changing max 401(k) contribution limits, which are due to shift again in 2022, Roth IRA is not an exception. Keeping track of the latest rules and knowing what to do about them are the key parts of good personal financial management. If you do not know the meaning of Roth conversion rules 2022, read our article and get the answer.

Proposed Roth IRA conversion rules for high earners

If you are looking for tax-advantaged savings vehicles, you might be weighing up the 529 plan vs Roth IRA. With Roth IRA, they offer a retirement account with many advantages for employees. Before taking advantage of a Roth IRA, you should know that Roth IRA conversion rules can change from year to year. 

The bill will eliminate the “backdoor Roth conversion” from 2022, which is considered a roundabout way to contribute to a Roth IRA by high-income individuals. Roth IRA conversion rules would impose a new requirement on the rich whose balances are at least $10 million across any defined contribution retirement accounts like IRAs or 401(k)s to make withdrawals.

The IRS expanded the Roth IRA income limits in 2022, allowing you to earn more money while still benefiting from the tax-free Roth account or the tax-deferred traditional IRA. However, Roth conversion rules 2022 would stop you from taking advantage of Roth IRA conversion. 

Any individual taxpayers earning above $400,000 per year, and married couples earning more than $450,000 a year, could not contribute to their savings. They also would be required to withdraw 50 percent of any amount above the $10 million thresholds. Let’s take an example. If you had $20 million in an IRA and 401(k) at the end of 2030, you would have to take out $5 million under Roth IRA conversion rules. 

Roth IRA conversion is a key way to build tax-free savings, but starting 2022,  it may get the axe. (Source: Pixabay)

Plus, Roth conversion rules 2022 require a more difficult provision applying to any individual or couple with income greater than the thresholds above, with defined contribution retirement accounts of more than $20 million, and any portion of that amount in a Roth account. They have to withdraw either the entire Roth portion or a portion of all accounts provided their combined balance would be $20 million maximum.

No more “backdoor Roth IRA” and “mega backdoor Roth 401(k)s”

Both “backdoor Roth IRA” and “mega backdoor Roth 401(k)s” would be prohibited with the Roth IRA conversion rules starting next year. This means you would no longer be able to convert after-tax contributions made to a traditional IRA or 401(k) to a Roth IRA regardless of income level.

High-income taxpayers are currently allowed to make nondeductible contributions though they are deterred from making deductible ones to a traditional IRA. When transferring a nondeductible IRA to a Roth, you would owe tax on the gains accrued on your contributions, but it is avoidable with a backdoor Roth conversion. 

Roth 401(k)s have no income eligibility rules that allow for much higher contributions. Like Roth IRA, now high-income earners may convert pre-tax and after-tax savings from your 401(k) account into a Roth without having to pay taxes on future withdrawals. This is known as a “mega backdoor” strategy; however, under Roth conversion rules 2022, “mega backdoor” would be totally prohibited.

Your savings will grow in no time if the conversion is immediately made after you make your non-deductible IRA contribution. (Source: Pixabay)

Would Roth conversion rules 2022 impact you?

In the USA, Roth conversions have little effect on middle-income earners: Out of almost 52 million, only 86,000 taxpayers who made between $50,000 and $100,000 even used a Roth conversion in 2018. 

Under Roth IRA conversion rules, anyone with income exceeding $400,000 (individuals) or $450,000 (married filing jointly) would also be prohibited from converting their pretax savings into a Roth.

When it comes to Roth conversion rules 2022, New Jersey-based CPA and certified financial advisor Joseph Doerrer reveals that he is strategizing when and the amount of savings for his high-income clients to convert to a Roth before the window potentially closes for them in 2032.

“We’re modeling out smaller piecemeal conversions, if we have any favorable play in their tax brackets, to chip away at their pre-tax balances in the event there is the 10-year or so proposed window after which Roth conversions would be unavailable to higher-income individuals.”, said Doerrer.

Despite targeting the upper class, the bill would not address the needs of the middle class. They already use an employer-sponsored retirement, but they don’t have enough to save. According to the Federal Reserve, just over 50% of households between 55 and 64 have a retirement account and have a median holding of just $134,000. Once they stop working, they hardly have enough to live on.

Even if Roth IRA conversion rules are enforced, these accounts will still be useful for savers meeting the income and other eligibility rules governing Roths. (Source: Pixabay)

So, don’t let yourself fall into that zone. Starting with a strong retirement income strategy will help you have enough finances to secure a comfortable retirement.

The bottom line

The bill will mainly impose more restrictions on high-income earners. Also, any Roth conversion rules 2022  have to wait for a later date, so keep calm and flexible when the legislation changes.

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