March 2, 2016

Are money-saving retirement tax strategies coming to an end?

Recently, President Obama released his proposed fiscal 2017 budget. It included several changes to tax strategies that have historically benefitted the taxpayer. While it appears unlikely that the president’s 2017 budget will pass as presented, taxpayers should be mindful of and prepare for these potential changes, which could occur soon or be a harbinger of things to come.

A couple of the proposed changes we think important to discuss relate to Roth IRAs. A Roth IRA is a retirement account in which taxpayers receive no immediate income tax benefit on contributions made, but enjoy tax-free withdrawals in the future. Anyone is eligible to contribute to a Roth IRA at any age, provided they have earned income. Roth IRAs are appealing to those who expect their tax rates to be higher during retirement than they are today. Additionally, Roth IRAs allow taxpayers to leave tax-free assets to their heirs.

High-income earners were prohibited from contributing to Roth IRAs until the so-called “Back door” technique was introduced, which currently gives taxpayers the right to make after-tax contributions to a conventional IRA or 401(k), then immediately convert into a Roth. This strategy would be eliminated under the president’s proposed budget, by limiting Roth conversions to pretax dollars.

The president’s proposed budget also includes the introduction of mandatory withdrawals from Roth IRAs. This would require minimum distributions for Roth IRA holders starting at age 70 1/2 and would prevent additional contributions to Roth accounts after age 70 1/2. Currently Roth account holders are exempt from required distributions.

Another provision in the president’s proposal also worth mentioning relates to traditional IRAs. As it presently stands, if a taxpayer dies owning a traditional IRA or 401(k), his or her heirs must pay taxes on the withdrawals they take, but have the option to stretch these withdrawals across their own lifespans, prolonging the tax advantages. The president’s 2017 budget proposes to eliminate this stretch IRA to most beneficiaries, other than spouses, by requiring heirs to liquidate these inherited accounts within five years.

As always, our advisors at Maddox Thomson stand ready to help answer your questions and guide you through the ins and outs of these proposed reforms to devise the right tax strategy for you.