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Spokane, Washington  Est. May 19, 1883

Michelle Singletary:

By Michelle Singletary Washington Post

Any mention of a tax hike and people’s blood pressure increases.

Tax revenue runs the government, and as a new budget cycle approaches there’s a lot of discussion about who’s not paying their fair share.

Competing tax proposals from the White House and Congress include increases in individual and capital-gains tax rates – but just for the super-wealthy.

It was 2017 when Congress enacted major tax legislation that gave a huge tax break to corporations but also expanded the standard deduction. Still, many felt the uber-rich weren’t taxed enough.

“Much of the income of wealthy households doesn’t appear on their annual tax returns, and much of what does appear enjoys special tax breaks or discounted rates,” a report this last week by the Center on Budget and Policy Priorities points out. “… These changes would make the tax code more equitable by taxing income from wealth more like income from work.”

So much can change before any legislation is passed and signed into law. But for now, here are answers to questions you might have on how the proposals could affect your retirement planning.

What individual tax hikes are being proposed?

The Biden administration’s proposed American Families Plan would increase the top marginal income-tax rate from 37% to 39.6% for those earning more than $452,700 for single filers, $481,000 for head-of-household filers and $509,300 for joint filers, according to an analysis of the proposal from the Tax Foundation.

The plan would tax long-term capital gains as ordinary income for taxpayers with an adjusted gross income of more than $1 million. This would result in a top marginal rate of 43.4% when including the new top marginal rate of 39.6% and the 3.8% Net Investment Income Tax, according to the Tax Foundation.

The House Ways and Means Committee released a competing proposal last week that would also increase the top individual rate to 39.6%.

This marginal rate would apply to single filers with taxable income more than $400,000, heads of households more than $425,000 and married couples more than $450,000, according to the House plan.

The top capital gains rate would increase from 20% to 25%.

For most people, these changes shouldn’t affect their retirement accounts, said Mark Hamrick, senior economic analyst at Bankrate.

“The average American, meaning someone who is middle-income, probably doesn’t have that much to be concerned about here,” he said. “But what I would say is just continue to watch this space in the coming years.”

The need to raise tax revenue to address the federal deficit might change things, Hamrick said. “The math has not been adding up for quite some time.”

How will the House tax plan affect Roth IRAs?

A Roth account is funded with after-tax dollars. Future withdrawals remain tax-free as long as you meet certain holding requirements. The current annual limit for a Roth is $6,000. If you’re 50 or older, you can contribute an extra $1,000.

The Roth 401(k) is increasingly being made available in employer workplace retirement plans. You still fund the Roth with after-tax dollars, but the annual contribution limit for a Roth 401(k) is the same as for a 401(k), which in 2021 is $19,500. People 50 and older can contribute an extra $6,500.

There are income limits to contributing to a Roth. Your modified adjusted gross income must be under $140,000 for the tax year 2021 if you file as an individual. If you’re married and file jointly, your MAGI must be under $208,000.

But a backdoor loophole allows higher earners to convert their traditional IRAs or 401(k)s into a Roth. A ProPublica investigation found that Peter Thiel, one of PayPal’s founders, had accumulated $5 billion in a Roth IRA.

This revelation has led to a lot of discussion about limiting what rich folks can stash in a Roth.

The House legislation would create new rules for taxpayers with large IRAs and workplace retirement accounts. Contributions would be prohibited if the total value of an individual’s IRA and workplace retirement account exceeded $10 million as of the end of the tax year.

The limit on contributions would apply only to single taxpayers (or taxpayers married filing separately) with taxable income more than $400,000, heads of households with taxable income more than $425,000 and married taxpayers filing jointly with taxable income more than $450,000.

Additionally, if an individual’s combined traditional IRA, Roth IRA and workplace account balances exceed $10 million at the end of a taxable year, a required minimum distribution, or RMD, would be required for the following year.

“They’re looking at putting gates around retirement accounts to prevent them from being supersized,” said Eric Bronnenkant, head of tax for the online financial adviser Betterment. “For the average person, I’m not too worried that they are going to bump up on these limits.”

With possible tax increases, should I fund a Roth IRA?

It’s possible that there will be a huge influx of money going into Roth IRAs because of fear of the possibility that tax rates will be higher in the future.

For younger investors or folks with lower incomes, a Roth account makes sense because they’re likely to be in a relatively lower tax bracket and the tax-free growth with years of compounding can outweigh the benefit of current-year tax deductions for contributions to a traditional 401(k).

If you’re in a high tax bracket at present but expect to be in a lower one when you retire, it might make more sense to get an upfront tax break now by contributing to a regular IRA or 401(k) rather than a Roth account.

Whatever you decide, the important thing is to save as much as you can for retirement, Hamrick said.

“People would be wise to try to optimize their tax savings,” he said. “I hope that people would look at the options that include Roth and all the other good savings vehicles that are out there.”