A Popular Tax Trick for Savers, the Mega ‘Back Door’ Roth IRA, Is Eliminated in House Bill

The mega-backdoor Roth strategy lets participants in 401(k) plans that allow after-tax contributions put as much as $58,000 a year into a 401(k) account and convert a substantial chunk of the money to a tax-free Roth account, potentially with a minimal tax hit.

Starting Jan. 1, 2022, the bill would also eliminate backdoor Roth conversions of after-tax contributions of as much as $6000 to traditional IRAs, or up to $7000 for those 50 and older. The strategy is often used by single individuals with incomes above $140,000 and married couples making more than $208,000, who aren’t eligible to make Roth IRA contributions.

One of the more far reaching IRA and 401(k)-related provisions in the bill wouldn’t kick in for another decade. Starting in 2032, the legislation would prevent single people earning more than $400,000 a year and married couples with incomes above $450,000 from converting pretax retirement-account money to Roth accounts.

In a traditional pretax retirement account, savers generally subtract contributions from their income, reducing taxes. Instead, they pay income tax when they withdraw the money in retirement. In a Roth, owners contribute after-tax money, which grows tax-free and can generally be withdrawn tax-free.

Starting in 2029, the measure would prohibit contributions to IRAs for single people with incomes over $400,000 and married couples making over $450,000, who have aggregate retirement account balances above $10 million.

It would also require higher income people with aggregate retirement-account balances above $10 million to take distributions, regardless of their age.

High-balance retirement accounts came under scrutiny after news site ProPublica reported that business titan

Peter Thiel

amassed $5 billion tax-free in a Roth IRA.

Democrats dropped provisions that would have banned holding unregistered securities, including private equity, in IRAs.

The mega-backdoor strategy rests on a little-known fact about 401(k) plans: The Internal Revenue Service lets employees set aside as much as $58,000 a year in a 401(k) account, a number that rises to $64,500 for those 50 or older. To get to the $58,000 annual limit, a worker can put $19,500–or $26,000 if 50 or older–in either a traditional pretax 401(k) or a Roth 401(k). If the plan allows, the person can also make an after-tax contribution of as much as $38,500.

Many 401(k) plans don’t allow mega-backdoor Roth conversions. But in recent years, a growing number have added the feature. It is available at many large companies that employ people with the means to save significant sums, including

Aon

PLC,

Facebook Inc.,

and

AT&T Inc.,

according to the companies.

Nearly 20% of the 23,500 401(k) plans administered by Fidelity Investments allow the mega-backdoor strategy. Of the 19.5 million people enrolled in Fidelity-managed 401(k)s, 47% are in plans that offer both after-tax contributions and Roth 401(k) conversions, although far fewer use the combination.

Under the legislation, employees would still be allowed to make after-tax contributions to 401(k)s. But they would no longer be permitted to convert that money to a Roth, where profits can grow tax-free. Instead, they would pay income tax on their investment gains when they withdraw the money.

Write to Anne Tergesen at anne.tergesen@wsj.com