Roth Retirement Accounts and the Biden Tax Plan
As the Biden administration moves forward with massive spending packages, he has made it clear that tax hikes on business and individuals are coming soon. Tax and investment advisors are calling their clients and recommending Roth accounts over conventional IRA and 401(k) accounts.
Roth or Conventional?
What is the difference? The main difference is in when you pay taxes on the retirement money. With the conventional accounts, you deposit money pre-tax. You get to put off paying taxes on the money until you withdraw it in retirement. A Roth account is the opposite in that you deposit after tax dollars. You pay taxes on the money you put into the account, but then you do not have to pay income taxes when you withdraw in retirement.
The decision to take the Roth approach is based mostly on the fact that you expect income tax rates in the future to be higher than they are now. This is especially true if you expect to see higher tax brackets penalized with higher rates in the future due to the “well off should pay their fair share” approach.
Biden’s Tax Plan
The Biden administration has indicated on numerous occasions that the intent is to raise taxes on those whose income exceeds $400,000 per year. This is one of their methods of funding the many initiatives proposed for infrastructure and social programs. The top individual tax rate is expected to be increased to 39.6%, up from the current 37%. That is the level in place prior to the 2017 Tax Cuts and Jobs Act. Most tax experts expect the rate increase to go into effect, as it has been promised during the campaign and after the election on a regular basis.
Other Tax Possibilities
While the extra 2.6% in the individual rate may not rise to the level of alarm for many, it should be considered in the context of other tax initiatives in the works. Combining them could have a dramatic effect on your lifestyle in retirement.
- Estate Tax – The plan is to lower the estate tax exemption to subject more estates to the tax. Currently, a 40% federal estate tax applies to estates exceeding $11.7 million in value for individuals and $23.4 million for married couples.
- Bequests – The plan is to also lower the threshold to $3.5 million in bequests at death. Senator Bernie Sanders wants to tax estates valued over $3.5 million at 45%, and those valued at over $1 billion at 65%.
In the context of retirement savings, these are significant proposals. A Roth conversion helps in that the size of the estate is reduced by the amount of income tax paid on that conversion.
It is Not Just About the Rich
Currently, conventional pre-tax retirement accounts get a tax break based on the tax bracket of the saver.
- 12% bracket gets a $12 deduction on $100 deposit.
- 37% bracket gets a $37 deduction on $100 deposit.
The new Biden plan would eliminate the bracket structure with an across-the-board 20.5% deduction. This is a significant reduction of 16.5% for top bracket savers. This could be another reason to look at conversion to a Roth.