Delayed ‘mega IRA’ provisions boost budget bill’s revenue take

Section aims to cap amounts held in both traditional and Roth IRAs

House Ways and Means Chairman Richard E. Neal, left, and Senate Finance Chair Ron Wyden have been in lockstep on the proposal to crack down on “mega IRAs.” (Bill Clark/CQ Roll Call file photo)
House Ways and Means Chairman Richard E. Neal, left, and Senate Finance Chair Ron Wyden have been in lockstep on the proposal to crack down on “mega IRAs.” (Bill Clark/CQ Roll Call file photo)
Posted November 12, 2021 at 10:00am

Democrats are getting more revenue they can count toward paying for their roughly $2 trillion social spending and climate package thanks to tweaks to a provision that would set new limits on how much cash can be stowed away in tax-free retirement accounts.

The proposal to crack down on “mega IRAs” will generate about $7.3 billion in revenue over a decade, up from $1.8 billion in its original form in legislation the House Ways and Means Committee approved in September, according to Joint Committee on Taxation estimates.

That’s because a delay in implementing the first-time mandates makes for beneficial math within the decade-long budget window used to calculate the cost of the filibuster-proof reconciliation bill. At the same time, Democrats swapped in a tighter income limit for households that have to adhere to the new rules.

Calls for new curbs on high-balance individual retirement accounts got louder this year after a ProPublica report on how wealthy investors like billionaire PayPal co-founder Peter Thiel have used IRAs to grow their fortunes while avoiding taxes.

Senate Finance Chair Ron Wyden, D-Ore., and Ways and Means Chairman Richard E. Neal, D-Mass., highlighted the issue in late July, releasing JCT data that found 3,625 taxpayers had IRAs with balances of at least $10 million as of 2019. Their accounts held more than $119 billion all together.

While Wyden and Neal have had to negotiate differences on many other pieces of the reconciliation bill, they’ve been in lockstep on the mega IRA provisions, which staff from both committees developed jointly.The section aims to cap amounts that can be held in traditional IRAs as well as Roth IRAs, which have some important differences.

Traditional IRAs allow account holders to put away each year a limited sum that they’re able to deduct from taxable income if they earn up to certain amounts, though eventually they are taxed on the withdrawals at ordinary income rates. Nondeductible contributions are allowed for upper-income individuals.

Roth accounts, named for the late Senate Finance Chairman William V. Roth Jr., R-Del., allow after-tax contributions that grow and are eventually withdrawn tax-free. But annual contributions face the same limits as traditional IRAs, and individuals making above certain income thresholds aren’t eligible to contribute. One way around those income limits is through workplace savings plans, if offered, in which employees can park after-tax dollars in Roth-designated 401(k) accounts with higher annual contribution limits. 

Unlike traditional savings accounts or brokerage accounts, in which taxes are levied annually on the interest and dividends that accrue, IRAs provide an incentive for retirement savings by avoiding those drawbacks. But Democrats are aiming to strip that benefit from wealthier households.

The version in Democrats’ latest bill is tweaked from what Ways and Means approved in September. They made the changes for policy reasons, but that also resulted in a higher revenue tally, according to Democratic aides with knowledge of the issue.

The latest proposal would block individuals with more than $400,000 in adjusted gross income, heads of household making over $425,000 and married couples filing jointly with earnings over $450,000 from putting more money into IRAs if the total value of their retirement accounts, including workplace savings plans like 401(k)s, swell above $10 million.

If someone with income above those thresholds has a balance across their retirement accounts over $10 million, they’d have to withdraw half the amount above that limit each year they’re over the limit.

If balances climb above $20 million, account holders would have to take out enough from their Roth IRAs and Roth-designated workplace accounts to get back down to that threshold, or if less than that, at least withdraw whatever amounts are held in Roth accounts.

Ways and Means originally proposed implementing those rules next year, but the latest version has the start date pushed back to 2029.

Generally, the proposals are estimated to generate revenue because they force individuals to take money out of retirement accounts sooner than they would have under current law, and the withdrawals from traditional IRAs or tax-deferred employee accounts would be taxed at that time.

Lawmakers settled on delaying the implementation because they heard from those it might impact that it would help to have more time to take their investments out of certain assets before the rules hit, according to a committee aide. Democratic aides also said lawmakers wanted to allow a transition period to the new regime.

More time, more money

The delay had an added bonus: a bigger revenue boost. Originally, the Ways and Means version generated a net $1.8 billion over a decade from rules requiring minimum amounts be withdrawn from large accounts. The latest version generates $7.3 billion from that alone.

The JCT’s original estimate showed that after four years, the new rules would mean lost revenue because withdrawals that would’ve been made in those years would have already been taken. By pushing the implementation date to 2029, revenue losses fall outside the 10-year budget window, so only the revenue gains count towards the bill’s cost estimate.

Another tweak that led to higher revenue was a switch from measuring the $400,000 and up thresholds at which the rules apply based on adjusted gross income, rather than taxable income as originally proposed. Taxable income factors in deductions such as money donated to charity and paid in state and local taxes. That means the new threshold would be more stringent and apply the IRA rules to more taxpayers.

There might be even more money on the table that congressional estimators haven't factored in, one expert said.

The Tax Policy Center’s Steven Rosenthal, a former JCT legislative counsel, said the goal isn’t just to generate revenue by forcing early distributions. It also would force wealthier individuals — who are more likely to save money regardless of tax incentives to do so — to take dollars out of tax-advantaged accounts and move them into bank or brokerage accounts where money accruing from interest or investments is taxed.

Those additional taxes aren’t a significant factor in the JCT’s estimates, he said.

“It’s a step in the right direction but a small step and a delayed step,” said Rosenthal, who weighed in with Finance and Ways and Means on the provisions’ drafting. “We have a retirement tax system that is entirely broken. It’s upside down. … It rewards and encourages savings to those who don’t need any help.” He said wealthy, white households save the most for retirement.

Ways and Means originally aimed to address gaps in the system by devoting more than $40 billion to a plan to expand a tax credit for low-income retirement savers and require most employers to auto-enroll their workers in savings plans, a longtime priority for Neal. Democrats cut that piece of the bill due to pressure from Senate centrists Joe Manchin III of West Virginia and Kyrsten Sinema of Arizona to reduce spending.

‘Backdoor Roth’ strategy

The revised bill includes other pieces unchanged from Ways and Means’ original version, including provisions intended to crack down on conversions from traditional IRAs or 401(k) accounts to tax-free Roth plans.

Lawmakers over the years have generated revenue offsets by offering more opportunities for such conversions, which are taxed upfront. The flip side of those rules is more money in Roth accounts, meaning less money available to be taxed in the future — what critics call a “backdoor Roth” strategy enabling richer households to build more tax-free wealth. 

The reconciliation bill would eliminate the ability for retirement account holders to convert nondeductible, after-tax IRA or workplace plan contributions to Roth accounts starting next year. And after 2031, it would end the ability of households making more than $400,000, or $450,000 in the case of married couples, to convert any traditional IRA or pretax workplace plan contributions to Roth accounts. 

The JCT estimates those two provisions combined would raise about $2.7 billion in the 10-year budget window, as more savers convert pretax rather than after-tax funds or accelerate conversions that might otherwise occur after 2031. 

Democrats dropped other retirement-related items from the revised bill, including a provision that would have prevented individuals from holding certain restricted investments in IRAs. Those include securities available only to accredited investors, like unregistered investments in startup firms that haven’t yet gone public. That provision would have raised $1.7 billion, the JCT said in September.

Another dropped provision, estimated to raise just $42 million, would have tightened rules that limit self-dealing in IRAs, including by blocking account holders from using them to invest in businesses where they’re an officer.

Rosenthal said the aim of those rules was to limit IRA investments to publicly traded securities rather than private businesses, which wealthy investors can undervalue to skirt taxes. Ways and Means included a two-year transition rule for such investments that are already held in IRAs to try to cushion the blow, but lawmakers still heard significant concerns about those provisions and couldn’t figure out a fix that made sense, a committee aide said.