Democrats revive Roth IRA, 401(k) limits for wealthy Americans in latest spending proposal

House Democrats on Wednesday unveiled an updated version of the party’s sweeping social spending package, adding several rules designed to curb wealthy Americans' ability to contribute to tax-advantaged retirement accounts.

Legislation released by Wednesday evening by the House Budget Committee resurrects retirement law changes that target strategies used by the rich to grow their money and reduce their tax liability. The perfectly legal practice has come under scrutiny by Democrats in recent months since a ProPublica story highlighted how PayPal co-founder Peter Thiel grew investments of about $1,700 tax-free in a Roth IRA, eventually amassing close to $5 billion. 

For instance, the $1.75 trillion package restores limits on so-called "mega IRAs," preventing more money from being added to a Roth or traditional individual retirement account if its value exceeded $10 million. The restriction, which would not take effect until 2029, would apply to individuals who make over $400,000 and married joint filers with more than $450,000 in annual income. There are exceptions in place for SEP-IRAs, SIMPLE IRAs and rollovers.  

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Under the proposal, wealthy Americans with account balances above $10 million would have to draw down their accounts by a certain threshold each year, thereby triggering taxes on the money. 

How much individuals must take from the account each year is a complicated formula that includes different factors such as account size and type (i.e. Roth or pretax). The general rule is that anyone with more than $10 million in an account must withdraw at least 50%. Those with more than $20 million would be required to withdraw 100% of anything over that $20 million threshold in their Roth accounts. (For instance, Thiel could be forced under this legislation to withdraw all but $20 million from his Roth IRA).

Roth IRAs are appealing to the wealthy because contributions are taxed upfront, allowing individuals to grow their investment earnings tax-free (unless the money is withdrawn before an individual is 59.5 years old).

The provision would take effect after Dec. 31, 2028. 

Although the proposal was included in an earlier version of the social spending and climate plan, President Biden omitted it from a framework that he unveiled last week as Democrats considered a spate of other changes to the tax code.

Democrats also restored several other changes to retirement accounts, including eliminating what's known as a "backdoor" Roth IRA. In that scenario, account holders with income too high to contribute to a Roth (in 2021, individuals had to have a modified adjusted gross income below $139,000) instead place the money in traditional IRAs – but then convert it to a Roth. There are taxes at the time of the transfer, but then individuals can grow that money tax-free in a Roth.

"A big first step to strip retirement tax benefits from those who don't need the help," said Steven Rosenthal, a tax lawyer and policy analyst at the left-leaning Tax Policy Center. "Still a lot more to do."

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It remains unclear whether all Democrats on Capitol Hill will agree to pass the massive tax and spending package, along with a $1 trillion bipartisan infrastructure bill. 

There were no immediate signs of a détente this week between progressives and moderates, though the House is barreling forward with a vote as soon as this week on the $1.75 trillion plan.