One reason we advise our clients not to overreact to election results is that the plans candidates propose on the campaign trail often look very different once they've worked through the U.S. lawmaking process. President Biden's agenda has struggled with that very reality in recent weeks. As Congress continues to debate and negotiate the Build Back Better Plan, perhaps the central topic of discussion has been balancing ambitious spending with changes to tax codes that would be necessary to pay for that spending.
We wanted to devote today's show to answering some of the questions that our clients have been asking about the Build Back Better Plan and their own tax planning. Rather than leaning one way or the other politically, our discussion stays centered on the numbers and potential rule changes that could affect retirees -- particularly high earners.
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1. A new top tax rate and bracket.
Currently, individual filers who earn $523,601 or more and married couples filing jointly who earn $628,301 or more pay a 37% marginal federal tax rate. The Build Back Better Plan proposes raising that rate to 39.6% while also lowering the highest-earner threshold to $400,001 for single filers and $450,001 for married couples filing jointly.
While those are pretty significant adjustments to tax rates and brackets, it's an especially steep increase in the so-called "marriage penalty." Couples in lower brackets have nearly twice the tax liability range of single filers in the same bracket. That range shrinks the more you earn, and under this proposal it would all but disappear at the top bracket.
2. New and old capital gains taxes.
During his campaign, President Biden proposed taxing capital gains over $1 million as ordinary income, which means certain high-income earners and investors would have to pay a top rate of 39.6% on their capital gains above the first $1 million. It doesn’t look like the president’s proposal will make it into law.
Instead, Congress is discussing a new top capital gains tax rate of 25% for individuals making $400,000 or more and married couples earning $450,000 or more, while leaving the lower brackets intact. That means that lower earners -- including comfortably retired seniors who aren't earning much taxable income -- could still pay 0% on capital gains up to $40,400 in total income for individual filers and $80,800 for couples filing jointly. These changes also wouldn't affect anyone who had binding contracts in place prior to September 13, 2021 that will result in capital gains, such as selling a business.
3. Closing the "back door" for high earners.
Under current rules, high earners who do not qualify for Roth IRA contributions can make after-tax contributions to a traditional IRA and then convert those funds into a Roth IRA. The Build Back Better Plan would eliminate these "back door" Roth IRA contributions. The plan also proposes eliminating Roth IRA conversions for all earners in the highest tax bracket starting in 2032. Perhaps Congress is betting that this 10-year timeline will encourage more high-earning seniors to start taking money out of their IRAs, which would generate a bit more tax revenue.
A much smaller group of high earners would be affected by what some are calling "The Peter Thiel Rule." Thiel, the billionaire tech investor and co-founder of PayPal, put corporate shares into a Roth IRA that's now worth $5 billion. That story got Congress' attention, as it's not really in the spirit of IRAs to use these tools to shelter that much money from taxes. New rules propose that individuals and couples who are in the highest tax brackets who also have more than $10 million total in their retirement accounts would have to start taking required minimum distributions from those accounts, regardless of their age.
4. Still working on the votes.
Two significant proposals that aren't in the current draft of the Build Back Better Plan are an elimination of the step-up in cost basis for inherited investments and an expansion of the state and local tax (SALT) deduction. It's possible that these and other provisions could work their way into the bill as negotiations continue, but as I write this Congress and the President are still struggling to find enough common ground to move towards a final vote.
Which brings me back to my first point: don’t panic about proposals. History tells us that, for the most part, the markets are apolitical. And while our politics can have a more direct effect on taxes and inflation, we need to see the final details of the Build Back Better Plan before making any definitive conclusions.
We’ll be sure to follow up if Congress sends the bill to President Biden’s desk, but if you have any questions about your retirement tax picture in the meantime, don’t hesitate to get in touch.
Bill Keen is a CHARTERED RETIREMENT PLANNING COUNSELOR℠ and independent financial advisor with more than 25 years of industry experience. As the founder and CEO of Keen Wealth Advisors, a registered investment advisory firm, he specializes in providing personalized retirement planning designed to help people thrive before and during their retirement years. With a passion for educating others, Bill regularly blogs about retirement planning, hosts the podcast Keen on Retirement, and has contributed to U.S. News and World Report, Reuters, Wall Street Journal’s Market Watch, Yahoo Finance, and other publications. Based in Overland Park, Kansas, Bill and his team work with clients throughout the greater Kansas City area and across the nation. To learn more, connect with him on LinkedIn or visit www.keenwealthadvisors.com.
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