TIPRA and Roth IRA: What You Need to Know About the Law That Legalized Backdoor Roths

The Tax Increase and Prevention Reconciliation Act (TIPRA) of 2005 has generated plenty of controversy since it was signed into law by then-President George W. Bush in 2006. One of the legislation’s boldest moves was to lift income restrictions on individual retirement account (IRA)-to-Roth IRA conversions, starting in 2010, which paved the way for the so-called backdoor Roth IRA. This gives high earners a way to access the benefits of tax-free growth on retirement investment gains.

In late 2021, congressional Democrats almost found a way to close this loophole as part of President Biden’s Build Back Better (BBB) plan. The sweeping economic recovery and social welfare bill passed the U.S. House but stalled in the U.S. Senate. For now, higher earners can continue funding their Roth IRAs in 2022 even though their modified adjusted gross income (MAGI) should theoretically exclude them from being able to do so.

Key Takeaways

  • The Tax Increase and Prevention Reconciliation Act (TIPRA) of 2005 renewed low tax rates on dividends and capital gains and created a way for rich people to invest in a Roth individual retirement account (Roth IRA).
  • Roth IRAs initially were supposed to be exclusively for “hardworking, middle-class Americans.”
  • TIPRA created a loophole for anyone to start contributing to a Roth IRA by adding money to a traditional IRA, then immediately rolling over the funds to a Roth.
  • Before 2010, only people earning less than $100,000 a year could have done this.
  • President Biden is keen to outlaw backdoor Roth IRAs, but he has yet to garner enough congressional votes to push through these changes.

How Did TIPRA Come to Pass?

When unveiling TIPRA—which also extended tax cuts on long-term capital gains and qualified dividends as well as increased the alternative minimum tax (AMT) exemption amount—President Bush talked of the importance of keeping taxes low to ensure that the economy keeps growing. In his speech, the topic of pensions was also specifically brought up, with Bush mentioning how the act could help owners of an IRA or a 401(k) enjoy “a better retirement.”

According to a ProPublica investigative report, Bush and the Republican-controlled Congress wanted to cut taxes on capital gains in 2006, but they needed to find a way to balance the books first. In the end, they figured that if they lifted the restrictions on who can make Roth conversions, then lots of taxes would be paid up front, helping to fund the capital gains tax break via what effectively amounted to another tax cut.

How to Take Advantage of TIPRA’s Creation of the Backdoor Roth IRA

Roth IRAs were created in 1997 as a way for middle- and low-income taxpayers to have a shot at creating a bigger pension pot. These accounts offer the chance to pay income tax when contributing rather than when withdrawing the money later, which effectively means that all of the additional capital generated by investments can be accessed tax free.

The Clinton administration prevented wealthy people from profiting from this big tax break by phasing out the amount that you can directly contribute to a Roth IRA once your income hits certain levels and making it impossible for people who earn $100,000 or more per year to roll over pension funds from a traditional IRA to a Roth IRA.

That all changed with TIPRA. Under President Bush’s law, the $100,000 threshold was done away with, giving the wealthy a way in via the backdoor.

Earn Too Much for a Roth? Use the Backdoor

TIPRA didn’t suddenly allow high-income earners to contribute directly to a Roth IRA, as annual income limits remained in place. What it did was create an opportunity to deposit funds in a Roth IRA indirectly.

The play is to add capital to a traditional IRA—which doesn’t have income ceilings for participation—then roll over this money to a Roth IRA. Before 2010, only people earning less than $100,000 could have done this. With TIPRA, the option became accessible to everyone.

What Do People Think of TIPRA and the Backdoor Roth IRA?

Obviously, relatively high earners who have benefited from the loophole are delighted with it. They face opposition from dissidents very much against the backdoor Roth IRA and everything that it represents.

A popular opinion among detractors is that TIPRA just fattened the pockets of the wealthy while further bloating the federal budget deficit. According to them, the backdoor Roth IRA workarounds turned a retirement vehicle that was supposed to help regular working people into a tax-free piggy bank for the super-wealthy.

When introduced, it was promised that the Roth IRA would “provide relief to hardworking, middle-class Americans.” TIPRA changed that and made the Roth IRA a way to also add more zeroes to rich people’s retirement bank accounts.

Is the Backdoor Roth IRA on the Chopping Block?

For a few months in late 2021, it looked possible that backdoor access to Roth IRAs would be sealed off. The BBB bill approved by the U.S. House on Nov. 19 included a provision prohibiting wealthy people from funneling money into Roth IRAs via IRAs. That bill, however, ended up getting quashed by U.S. Sen. Joe Manchin, D-W.Va., in December 2021.

Biden remains committed to the framework of his BBB bill, but now he needs to find a compromise. Investors are nervously waiting to see if a revised iteration—assuming there is one—still includes plans to shut wealthy people out of using Roths and will garner enough support to become law. It could take weeks or months for those questions to be answered. Until then, TIPRA’s controversial backdoor Roth IRA remains an option on which everyone can capitalize.

Are backdoor Roth individual retirement account (Roth IRA) contributions still allowed in 2022?

As of the date when this article was written, the backdoor Roth individual retirement account (Roth IRA) option is still very much alive and there to be taken advantage of.

What is the modified adjusted gross income (MAGI) to qualify for a Roth IRA?

If you file taxes as a single person, your modified adjusted gross income (MAGI) must be less than $140,000 for the 2021 tax year and less than $144,000 for the 2022 tax year to contribute to a Roth IRA. Conversely, if you’re married and file jointly, the thresholds are $208,000 in 2021 and $214,000 in 2022. There are also limits for heads of household, qualifying widow(er)s and those married filing separately (different if you lived with your spouse at any time during the tax year).

What happens if I contribute to a Roth IRA and my income is too high?

The Internal Revenue Service (IRS) will charge you a 6% penalty tax on excess contributions each year until you fix the mistake.

The Bottom Line

Biden’s efforts to stop higher earners from profiting from Roth IRAs have stirred panic among some people who use this strategy. However, he hasn’t yet succeeded and might never do so.

As of today, the law permits backdoor Roth IRA contributions, and it’s generally in investors’ best interest to take advantage of them.

Article Sources

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  1. U.S. Congress. “H.R.4297 — Tax Increase Prevention and Reconciliation Act of 2005.”

  2. U.S. Congress. “H.R.5376 — Build Back Better Act.”

  3. Internal Revenue Service. “Amount of Roth IRA Contributions That You Can Make for 2022.”

  4. Govinfo (U.S. Government Publishing Office). “Congressional Record Volume 143, Number 111 (Thursday, July 31, 1997).”

  5. Journal of Accountancy. “2010: The Year of the Roth Conversion?

  6. The American Presidency Project. “Remarks on Signing the Tax Increase Prevention and Reconciliation Act of 2005.”

  7. ProPublica. “Lord of the Roths: How Tech Mogul Peter Thiel Turned a Retirement Account for the Middle Class Into a $5 Billion Tax-Free Piggy Bank.”

  8. Congressional Research Service. “Traditional and Roth Individual Retirement Accounts (IRAs): A Primer,” Pages 21–22.

  9. U.S. Code, Office of the Law Revision Counsel. “26 USC 408A: Roth IRAs.”

  10. Internal Revenue Service. “Roth Conversions/Retirement Planning for Life Events,” Page 7.

  11. The White House. “The Build Back Better Framework.”

  12. Internal Revenue Service. “2021 Limitations Adjusted as Provided in Section 415(d), etc.,” Pages 3–4.

  13. Internal Revenue Service. “Retirement Topics — IRA Contribution Limits.”

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