What Retirees Need to Know About the Inflation Reduction Act
What's in a name?
On Tuesday, President Biden signed the Inflation Reduction Act (IRA) into law (and let’s not confuse this IRA with the older “IRA” as in Individual Retirement Account). That's certainly less of a mouthful than, say, the Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019 and its proposed sequel. But will the IRA actually have an impact on inflation? Will it change how IRAs work? And what's this carried interest tax loophole that everyone was so worked up about?
These are just some of the questions that we've been fielding about the IRA at Keen Wealth. On today's show, we answer these questions and discuss five major bullet points about the new law.
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1. The "backdoor" Roth IRA conversion is still open -- if you're still working.
Closing backdoor Roth IRA conversions has been a discussion point ever since President Biden proposed his Build Back Better plan shortly after taking office. And while some elements of that plan are included in the Inflation Reduction Act, lawmakers ultimately decided to leave backdoor Roths alone. That means high earners who are ineligible to open Roth IRAs can still put money into a traditional IRA and then convert those funds into a Roth for tax-free growth. You do still have to be working and earning a wage.
In other words, while you might see "IRA" as shorthand for this bill, it doesn't make any changes to IRAs or other retirement accounts.
2. Higher health care subsidies have been extended.
As part of COVID-19 relief packages, Congress decided that folks shopping for health care on their state exchanges should pay no more than 8% of their income. These subsidies were set to expire at the end of 2022, but the Inflation Reduction Act extends them through 2025. High earners whose health care costs are below 8% of their income are still ineligible for subsidies.
Younger retirees who aren't eligible for Medicare yet should sit down with their financial advisor before the 2023 Open Enrollment period this November. There could be adjustments to your income streams that might help you take advantage of these extended subsidies and lower your insurance costs.
3. Some prescription drug costs are getting capped.
While a proposed cap on the cost of insulin didn't make it into the final bill, some prescription drug prices will be coming down for folks who are on Medicare. The Inflation Reduction Act eliminates the 5% coinsurance charge on catastrophic instances under Medicare Part D, and caps out-of-pocket prescription drug costs at $2,000. Additionally, the IRA allows Medicare to negotiate better prices with drug companies, starting with 10 drugs and expanding to 20 drugs by 2029. Changes like these are why it's so important to review your Medicare coverage during Open Enrollment every Fall.
4. Big companies will pay more taxes.
Some of our biggest companies, like Amazon, pay little-to-no taxes because of how they reinvest their profits and legally utilize certain accounting rules. Under the Inflation Reduction Act, companies with more than $1 billion of financial statement income will pay a 15% corporate minimum tax rate.
Market prices didn't plummet after the IRA passed, so it's safe to assume that large companies and investors were anticipating this change. But if huge companies decide to pay for their higher tax bills by raising what they charge consumers, the Inflation Reduction Act might actually drive-up costs of certain goods and services in the long run.
5. The carried interest tax loophole is still open.
The carried interest tax loophole was a particularly contentious topic of debate during the final rounds of negotiations. While many Democrats wanted the IRA to close this loophole, it remained open to secure enough votes for passage.
Without getting too far into the weeds, the carried interest tax loophole affects how hedge fund managers get paid and taxed for the profits of their funds. Essentially, the typical 20% “performance fee” that a manager earns on the hedge fund's annual profits is taxed at the long-term capital gains rate of 20%. Opponents of this loophole want these payments taxed as ordinary income, at rates which could go as high as 37%.
The hedge fund industry argues that lower tax rates allow hedge funds to invest in more companies, which helps small businesses. I'm not sure that's a very compelling argument as few hedge funds would go out of business if their managers had to pay a higher tax rate. But from the perspective of the typical investor who's trying to build wealth for a successful retirement, this complicated accounting is one reason why we don't offer hedge funds at Keen Wealth. Much like mutual funds, the fees and instability are often more trouble than they're worth, especially for folks who aren't working with an advisor and don't dig into the finer details.
Do you have any questions about the Inflation Reduction Act that we didn't cover in this podcast? Call up Keen Wealth and we'll connect you to an advisor who can help.
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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