White House Budget Proposals Would Hike Taxes on Retirement Accounts of the Wealthy

Retirement assets for the wealthiest could be on the chopping block.

President Joe Biden’s tax proposals, laid out in his fiscal year 2025 budget, include a provision that subjects any assets in excess of US$10 million that are sitting in tax-deferred and tax-free retirement accounts to required minimum distributions.

The budget also aims to slam the door on backdoor Roth IRA conversions for higher earners.

Broadly speaking, the president aims to enact a variety of measures that would raise taxes on big corporations and folks earning more than US$400,000 a year, or US$450,000 for married couples, while expanding tax credits and other relief for lower-income taxpayers.

Along with various other tax rate increases, detailed below, central to the plan to boost federal tax revenues and make the tax system more equitable is allowing certain temporary tax cuts passed by the Tax Cuts and Jobs Act of 2017 to expire on schedule by the end of 2025.

For example, individual income-tax rates would return to their pre-2018 levels—the top rate would rise to 39.6% from its current 37%.

As always, the prospect of tax rate increases is contentious, but there’s nothing that stirs debate more than proposals to tax accumulated wealth—and that’s where retirement assets potentially come in.

The budget proposes that 50% of any IRA assets in excess of US$10 million be withdrawn annually as a required minimum distribution, or RMD, regardless of the account holder’s age.

In addition, there would be a new US$20 million limit on IRA assets; any amount above that level would have to be taken out of the IRA account.

Current law requires IRA holders to make a required minimum distribution annually after turning age 73.

The proposed changes would create a windfall for the U.S. Treasury. That’s because withdrawals from regular IRAs are subject to income-tax rates, which currently top out at 37% but could rise to 39.6% in 2026 under the Tax Cuts and Jobs Act’s sunsetting schedule.

After-tax contributions to IRAs are not taxed when they are distributed, but they represent a percentage of any withdrawal along with growth. Taxpayers cannot choose to only take after-tax dollars out.

Another proposed provision is to prohibit Roth IRA conversions for people earning more than US$400,000, or US$450,000 for married couples.

This would prevent high-net-worth taxpayers from converting retirement assets to a Roth IRA through a so-called backdoor strategy. Backdoor conversions have become wildly popular among taxpayers whose income prevents them from contributing to a Roth IRA.

Among all retirement accounts, the Roth IRA is generally the most desirable because investors contribute after-tax dollars and eventually withdraw assets, including growth, completely tax free.

Roth IRA contributions are only permitted for single taxpayers with income up to US$161,000 and couples filing a joint tax return with income up to US$240,000.

But the backdoor strategy allows people to “inappropriately sidestep” those income limits and convert after-tax money from IRAs and 401(k)s to a Roth account.

Widespread use of this strategy was not expected by lawmakers when the Roth rules were established, says Mark Iwry, a nonresident senior fellow at the Brookings Institution and former senior advisor to the U.S. Secretary of the Treasury.

“Backdoor conversions were originally viewed as an aggressive loophole, but we’ve reached the point where this strategy has become widely used,” Iwry says.

The proposals affecting so-called mega RMDs and backdoor Roth conversions are an attempt to align current rules with the original purpose of tax-favored retirement accounts: to help middle- to lower-income people save enough to supplement Social Security and fund a secure retirement.

“Tax-favored retirement accounts were not created to tax-subsidize the accumulation of huge fortunes in retirement,” Iwry says.

Annual contribution limits were intended to prevent high-net-worth individuals from building significant wealth in the tax-favored accounts. This year’s contribution limit for 401(k)s is US$23,000 or, for folks aged 50 or older, US$30,500. For IRAs the limit is US$7,000, or US$8,000 if you are 50 or older.

But over time investors have built massive wealth in IRAs.

“If a Roth IRA invests in a large number of very cheap founder’s shares of an early-stage start-up that later becomes a PayPal or Microsoft, the shares could increase in value astronomically and tax-free,” Iwry says.

Among other proposals in the budget are an increase to the Medicare tax on wages and investment income for people earning more than the US$400,000 threshold to 5% from 3.8%, and increasing the long-term capital gains tax rate on folks with annual incomes of US$1 million or more to match income-tax rates—up to 39.7% from 20%.

Also spelled out is an intention to enact a 25% minimum income tax on taxpayers with a net worth of more than US$100 million. The White House cites data that currently, the average tax rate for billionaires in the U.S. is 8.2%, while the average worker is taxed at 25%.

Additionally, the corporate income-tax rate would rise to 28% from 21%, after being lowered from 35% effective in 2018.

What are the chances the IRA proposals, or any other, are passed by Congress?

That largely depends on which way political winds will be blowing after the November elections, Iwry says.

“No one expects changes like these to happen in this Congress,” he says. “But next year they will likely be part of a big bubbling cauldron of tax proposals expected to be the subject of robust negotiations on Capitol Hill.”