Biden’s ‘Historic’ Spending Plans Could Spur Rush to Roths

There could be a “cause and effect” in play in the retirement market as President Joe Biden unveiled his $2.2 trillion infrastructure package called “The American Jobs Plan” on Wednesday afternoon in Pittsburgh—and Roth retirement accounts may end up being the beneficiary in the long run.

The “once-in-a-generation investment” Biden rolled out would be paid for by what he calls “The Made in America Tax Plan,” which proposes significant changes to the corporate tax code (mainly raising the corporate tax rate from 21% to 28%) but not the individual tax code.

Wealthy individuals who thought their tax rates may be targeted in the infrastructure bill are not off the hook just yet. Changes to the individual tax code—at least for those making $400,000 or more—are expected by many to be a big part of the “pay-for” of Biden’s next big rollout, tentatively known as the “American Families Plan,” expected to focus on education and health care reform.

Joe Biden, Biden tax hikes
President Joe Biden. Image credit: © Andrew Cline | Dreamstime.com

While the details have yet to be released of that plan while the White House focused on The American Jobs Plan, the next phase of his “Build Back Better” recovery program could include, among other things, raising income tax rates on those making more than $400,000, changes to the estate tax, and a higher capital gains tax rate as ways to pay for yet another large tab.

There are other proposals from lawmakers on Capitol Hill that would raise taxes for high-earning Americans, such as Sen. Bernie Sanders’ (I-VT) the “For the 99.5% Act,” Sen. Elizabeth Warren’s (D-MA) Ultra-Millionaire Tax, and the STEP Act authored by Sen. Chris Van Hollen (D-MD), which seeks to get rid of the so-called step-up in basis and taxing the unrealized capital gains of unsold assets of wealthy estates at death.

The STEP Act would raise around $400 billion over 10 years, but would not apply to 401k plans generally exempt from capital gains taxes after death unless it is part of an estate that exceeds the $11 million threshold for individuals or $22 million for couples.

Where Roths come in

But it’s not just the wealthy who are preparing for a higher tax environment.

A net effect of all these possible tax hikes to pay for massive government programs? Quite possibly an even bigger rush toward conversions from traditional pre-tax 401ks and Individual Retirement Accounts to Roth 401ks and Roth IRAs from middle-class retirement savers. And a higher percentage of people starting retirement accounts going the Roth route from the get-go.

Driven by the belief that taxes (historically low at the moment) will go up in the future as the U.S. faces up to the mountains of debt the country has taken on to create stimulus and recovery packages in the wake of the COVID-19 pandemic, there is strong evidence that more people—especially younger workers—are wanting to pay taxes on their retirement accounts upfront with a Roth account.

In its Q4 2020 Retirement Analysis, Fidelity reported that the percentage of contributions to Roth IRAs continues to increase, rising to 58.7% of all IRA contributions in 2020. And Roth conversions have spiked: in 2019 there were 22% more conversions to Roth IRAs than in 2018—but in 2020, there were 67% more Roth conversions than in 2019.

Cerulli Associates reported last December that Roth IRA assets grew from $600 billion in 2014 to more than $1 trillion in 2019, represent the fastest-growing segment of the U.S. retirement market, and are well-positioned for future expansion with favorable demographic trends.

According to a Cerulli survey of retirement investors, individuals under the age of 30 are more likely to own a Roth IRA, while those over the age of 50 favor traditional IRAs.

Meanwhile, Roth options within employer-sponsored defined contribution (DC) plans are increasingly common. Cerulli believes that as more participants accumulate Roth balances in a DC context, Roth IRAs will experience more pronounced growth from rollovers.

That got a little easier for many people in 2020, when the CARES Act suspended required minimum distributions (RMDs). That waiver freed up money some people used to convert into Roths.

What’s next

FTT, financial transaction tax, Republicans
Image credit: © Rui G. Santos | Dreamstime.com

Nobody figures the proposal Biden announced Wednesday is going anywhere fast as it will face inevitable battles with Republicans and even progressive Democrats. While the wealthy and their financial advisors wait for the other shoe to drop in the form of Biden’s next expected proposal—the American Families Plan—many eyes will be focused on how exactly the President plans to pay for step two, expected to come in near the $2 trillion mark as well.

With corporate tax code changes being asked to carry the freight in paying for the bulk of the American Jobs Plan, expectations are heavy that the next plan will squarely target the (above $400,000-earning) wealthy in the form of individual tax code changes.

“While no increases to the individual income tax rate have been announced yet, many people believe it is only a matter of time,” said Jeanne Fisher, Managing Director with Strategic Retirement Partners in Nashville. “Despite his repeated promise to not raise taxes on for filers earning less than $400,000, many think it is inevitable given the significant stimulus spending that has passed or is pending.”

Beyond simply raising the federal income tax rate for high earners, it is widely expected the next bill will also adjust the estate tax by lowering the basic exclusion amount, which was essentially doubled by the 2017 Tax Cuts and Jobs Act. The basic exclusion amount for individuals is $11.7 million in 2021, compared to $5.49 million in 2017.

Sen. Sanders’ proposal—which may or may not find its way into Biden’s next package—would reduce the basic exclusion amount to $3.5 million and shift to a progressive tax rate structure where rates could reach as high as 65%.

A higher capital gains tax rate for individuals earning at least $1 million annually could also be part of the package, as the Biden Administration has repeatedly touted that changes he wants to make to the tax code should “reward work not wealth.”

But the bottom line for middle-class retirement savers? The potential of historically large stimulus and recovery programs like the ones the Biden Administration is floating figure to fuel a further influx toward Roth retirement accounts as retirement savers anticipate higher future tax rates.

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Biden’s ‘Historic’ Spending Plans Could Spur Rush to Roths