The Build Back Better Act passed the U.S. House of Representatives last week and the legislation includes a ban on backdoor Roth IRA conversions and mega backdoor Roth 401k conversions of after tax money after December 31, 2021. The U.S. Senate plans to take up the Build Back Better Act after Thanksgiving and hopes to land a budget neutral bill on the U.S. President’s desk by Christmas. It’s highly likely the Senate will change the bill and need to send it back to the House for approval one more time. It’s hard to say if the ban on after tax backdoor Roth conversions will get yanked out a second time or if the bill will pass at all given the political, budget and time constraints. Given this uncertainty I’ve come up with two plans for 2022 savings.
Plan A assumes the backdoor closes. In the middle of December, I’ll adjust my future 401k contributions as follows:
- After tax 401k contribution 10% -> 0% (without immediate Roth conversions, after tax money can be withdrawn earlier and possibly taxed less outside the 401k plan confines)
- Before tax 401k deferral 25% -> 35% (35% total either way, net pay will go up because taxable income and taxes go down)
- Mr. Plan A Total $74,223
- 401k $32,923 ($20.5k + employer match)
- HSA $7,300
- Vanguard after tax $24,000
- Cash $10,000 (minivan, bathroom remodel)
- Mrs. Plan A Total $72,263
- 403b $23,763 ($20.5k + employer match)
- 457b $20,500
- Vanguard after tax $12,000
- Cash $10,000 (minivan, bathroom remodel)
- Betterment after tax $6,000?
Plan B assumes the backdoor remains open to after tax Roth conversions and is a continuation of our 2021 savings plan with contribution limit increases. On January 3rd, we each make $6k nondeductible contributions to our traditional IRAs and convert them to Roth IRAs as soon as the ACH transfers clear a day or two later. This is done because joint income is too high to make direct Roth IRA contributions. Backdoor Roth: A Complete How-To.
- Mr. Plan B Total $74,223
- 401k $48,453 ($15.5k mega backdoor Roth)
- HSA $7,300
- Backdoor Roth IRA $6,000
- Vanguard after tax $12,000
- Cash poor $470
- Mrs. Plan B Total $72,263
- 403b $23,763
- 457b $20,500
- Backdoor Roth IRA $6,000
- Vanguard after tax $12,000
- Betterment after tax $3,000
- Cash rich $7,000
Regardless of plan A or B, it’s highly likely that Mrs. Dress Pockets’ after tax investments and cash will be larger than mine but I wrote the blog post so I’m the winner in draft form. I thought this was a healthy perspective on the potential loss of after tax backdoor Roth conversions (emphasis mine). Pay yourselves first!
Is it a big loss if the proposed changes become law and you can’t do backdoor Roth and mega backdoor Roth anymore?
It’s a loss because tax-free growth beats tax deferral on the earnings or the lower tax rates on qualified dividends and long-term capital gains. However, the power of saving and investing comes from making the contributions to begin with, not from how the investment returns are taxed.
A taxable account always works. In the end, even if all the tax-advantaged accounts go away and all the returns are taxed as regular income, those who save and invest more will still succeed. You take advantage of all available tax savings but you can’t stake your success on specific tax breaks.
The Finance Buff
