New Tax Law Changes Dangerous to Your Wealth

On a recent ChooseFI podcast where I was the guest speaker I mentioned the possibility the backdoor Roth and her sister tax strategy, the laddered Roth, could be going away. Many people heard me say it WAS going away. That is false. It is only a proposal at this time.

Because so many potential tax law changes now whispered in the halls of Congress have the potential to cause great damage to those in retirement or working an accelerated program toward financial independence (FI), now is the perfect time to review those with the highest possibility of happening. A word of caution before we begin. These are only ideas floating around Congress. They are NOT current tax law! Not all ideas whispered in the halls of Congress become law, but all laws start as a whisper in the halls of Congress. There is a difference.

Most ideas for tax law changes never see the light of day or are significantly modified before becoming a law. Some ideas become law in a few years, other may take a decade or longer before working through both houses of Congress and signed into law by the President. As we review the ideas now floating around Congress I will give my opinion on the likelihood the change will take place and how soon.

Remember, this is one guy’s opinion. My opinion carries weight because I have decades of experience. I also rely upon sources outside my own viewpoint, such as continuing education courses I’ve attended, The Kiplinger Tax Letter, and calls to several Congressmen. (It should be noted I rarely get to speak with an actual lawmaker. Usually I speak with a staff member. They can still be very helpful with potential tax law changes working through the system.)




What’s All the Hubbub, Bub?

The Republicans control both houses of Congress and the White House. There is a strong desire to cut taxes on businesses massively while not raising taxes on individuals. This is easier said than done. Cutting the top tax bracket for most businesses to 15% – 20%, while leaving individual rates unchanged, would blast a multi-trillion dollar hole in the federal budget. This is a serious problem.

The only way to make it work is to reduce or eliminate deductions and tax strategies. Congress can pass a tax bill without a tax bracket increase and claim they didn’t raise taxes even if what you owe goes up. But if you pay more in taxes it is a tax increase! So you can get a tax increase while the politicians smile big claiming they didn’t raise anyone’s taxes. Taxes make liars out of everyone, especially politicians.

Some changes make sense even if they hurt the demographic reading this blog. I don’t like the idea many powerful tax strategies might go away, but I understand why Congress may plug certain tax loopholes. Always remember I am on your side.




The original premise of this post started from my statement the backdoor Roth and laddered Roth would go away. I love the backdoor Roth, but it is really an end around of what Congress intended. The current law says you can contribute into a Roth IRA until your income reaches a certain level and then the Roth option is phased out until it is completely unavailable to high income taxpayers. The backdoor Roth is just a sneaky way to do an end around regardless of income. The laddered Roth the same.

Since the backdoor Roth raises very little tax revenue it is an easy target. Money not invested in a Roth IRA might be spent, increasing economic growth, leading to modest increases in tax collections by the government. The real advantage is down the road when the tax-free growth is taxed instead.

Once again, now is not the time to panic. This is NOT tax law yet. It may never happen. It could be effective January 1st of 2018, which is the earliest I think it could happen. A more likely outcome is a January 1st, 2019 effective date. Time will tell.

What all this talk of reducing the advantages of retirement plans you need to kick it in the tail and max out those retirement accounts now while you have the full advantage available. If ever there was a motivation to supercharge your FI goals, now is the time. The backdoor Roth and the following ideas to change the tax code makes waiting to up your savings rate a dangerous, expensive and wealth endangering exercise.

The Bad News Bears

Many of the ideas being toyed with by Congressmen are vague. What is coming out of Congress in whispers are not complete tax code changes. Some of what is reaching my ears requires some background tax knowledge to understand what is probably being proposed. Some of these ideas are so vague I am only making an educated guess as to how the change would be accomplished. Regardless, you need a basic understanding of what lawmakers are anticipating changing in the tax code. It is essential in your tax planning process.

Many of these proposals come from a 2014 tax reform plan that never got traction. As mentioned above, these things frequently take time before they start moving forward. Variations of some of these proposals are likely to be enacted.

Now it’s time to scare the bejesus out of you.

Have a seat, kind readers, there are lawmakers serious about a proposal to reduce the amount of pretax contributions to your 401(k) by up to half! The current annual contribution limit is $18,000 with an additional $6,000 allowed for those 50 and older. This means you could only deduct up to $9,000 per year or $12,000 for older taxpayers if this proposal is enacted. The key word here is pretax. The contribution level would still be $18,000, but any amount over $9,000 would automatically go into a Roth 401(k). On its surface this may not seem like a serious issue. However, it takes away a massive planning tool. Many credits are calculated off total income or adjusted gross income. Your mix of retirement investments between traditional and Roth plans can be modified each year to maximize your tax savings. If this controversial proposal becomes law it will seriously curtail your ability to reduce your tax burden by adjusting your retirement investment mix.

The above proposal also means if you are in a higher tax bracket while you are working—a common occurrence—you will be limited in your deduction at today’s higher tax rate and will be unable to take advantage of your lower tax rate in retirement.

Another idea floating around is to eliminate all traditional (deductible) IRA contributions, limiting IRA contributions to Roth IRAs only. As much as I love the Roth IRA, this accountant is horrified over the loss of flexibility from the loss of deductible retirement contributions. People do not save enough already in the U.S. These proposals will take away a massive incentive to get people to start or continue to save and invest.

Short-sighted goals to raise tax revenues for the government will end badly. The low savings rate of the U.S. would be forced lower to raise a small amount of revenue to offset massive tax cuts for businesses. The small added gain to economic growth would be temporary. With fewer savings, hence a smaller personal safety net, would exacerbate future recessions and strain the system more as people age; forget about early retirement.

Another bone-headed idea is to eliminate the Simple 401(k) and SEP plans. Existing plans would be grandfathered. This idea has been bounced around for several years now. If you are able to open a Simple 401(k) or SEP, now might be the time to preserve the option. (Note: Simple 401(k) plans look and act a lot like SIMPLE IRA plans.)

If all this isn’t damage enough, there are some lawmakers who favor cutting the cap on retirement contribution by employers and employees or freezing the contribution limits so they are not inflation adjusted. The Republican proposals are built on a foundation of discouraging savings and investments. Your favorite accountant does not favor short-term solutions to solve long-term federal budget problems. It seems to me if more Americans had a higher liquid net worth it would be better for the country, not worse.

According to Kiplinger (not an affiliate link), the White House claims retirement plan incentives are safe. Considering the current environment, I take no comfort, nor do I trust, what comes out of Congress or the White House. This could be a fight for the ages. Stay tuned.




Some (Modest) Good News

There are several proposals to improve S corporations. The most notable is allowing IRAs to be eligible shareholders. This could open powerful possibilities if it becomes law. There are additional S corporation changes proposed, but they will affect a much smaller group. Due to their complexities and time I will leave that discussion for another day when it appears the changes are imminent.

The one piece of good news seems unlikely to become law unless it is part of a larger tax reform bill.

Sorry for the downer this morning. It was too important to leave unsaid. You, kind readers, need this information to plan accordingly. Now more than ever it is imperative you increase your savings rate now. Eliminate debt, save and invest. A solid plan can reduce the damage the government inflicts. Those who wait will take the full blunt force of the assault.

As readers of this blog there is no need for you to be the victim.



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Keith Schroeder

18 Comments

  1. John on June 7, 2017 at 9:55 am

    “would blast a multi-trillion dollar hole in the federal budget” – I thought the entire Federal tax haul for a year was only about $3 Trillion. And corporate tax receipts are only 10% of that…

    • Keith Schroeder on June 7, 2017 at 10:07 am

      John, federal deficits are projected out 10 years and by law tax law changes are required to be revenue neutral for the first five years. The formula is complex on how they figure this stuff. The corporate tax cuts are listed on how much it will add to the deficit over ten years.

      Also, the business tax cuts go beyond regular corporate rates to include S corporations. S corps don’t pay income taxes in most instances so the tax benefit would flow to the personal tax returns of the owners.

      Add all this together and it comes to $800 billion per year, depending on which numbers you believe.The ten year projection would be close to $10 trillion added to the national debt, plus the added interest, plus all current projected deficits. It gets really big fast.

      • John on June 7, 2017 at 7:40 pm

        Got it. thanks for the clarification!

  2. Mimoza on June 7, 2017 at 10:33 am

    Keith,
    Could you please give an example for this quote: “The above proposal also means if you are in a higher tax bracket while you are working—a common occurrence—you will be limited in your deduction at today’s higher tax rate and will be unable to take advantage of your lower tax rate in retirement.”?

    I understand the first part, but not sure I understand the second. If as you say a person or a couple falls into a lower tax bracket in retirement, how can’t it be an advantage in general or what kind of advantages do they lose? I think an example would help me understand what your above sentence attempted to convey…I’m perhaps reading/comprehending it correctly.

    Thanks, M.

    • Keith Schroeder on June 7, 2017 at 10:47 am

      I hated that sentence when I wrote. It was edited several times and I knew it was still off. Here is the longer version of the one line: If you are forced into a Roth and pay tax at a higher rate due to the lost deduction you also lose the lower tax bracket when you retire. Example: Assume your tax bracket is 33% while you work and in retirement it drops to 15%. This is not unusual. By forcing retirement money from a traditional 401(k) into a Roth 401(k) there is also a 33% tax on the investment. It grows tax-free, but in retirement your bracket is only 15%! So regular 401(k) money is deducted at 33%, but tax is paid at a 15% rate years or decades into the future.

      This may not be an issue for some. I personally use a tradition retirement account and Roth products. By limiting what I can choose on my tax return takes away intelligently planning for maximum benefit. The limits are designed to raise revenue for the government. This is good the government, not you.

      • Jack on June 10, 2017 at 6:36 am

        But isn’t the Roth 401k contribution post tax? Typically this means it is not taxed on the way out. You pay the 33% up front (in this example), it grows tax free, then you pay nothing on the withdrawals later, right? So basically, it costs you the difference of 33% on the way in (Roth 401k), and 15% on the way out (regular 401k). About 22% more, but the math is not that simple, since with the Roth 401k, you aren’t paying the 15% taxes on your gains.

        • Keith Schroeder on June 10, 2017 at 7:37 am

          I agree, Jack. I think all this talk in Congress about messing around with retirement accounts is foolishness. And you are right, the Roth 401(k) is post tax, grows tax-free and withdrawals are tax-free.The math isn’t always so simple, I agree. The only way to show an example is within a narrow set of facts. It is the hardest part of writing this blog. No matter what you say about taxes you can always throw another variable into the mix and change the answer. It is the same reason why tax planning is so important. Without a plan you can overpay by a significant margin. Great points, Jack.

  3. Shelley on June 7, 2017 at 10:35 am

    What do you think of the likelihood that increasing HSA contributions will hapoen?

    • Keith Schroeder on June 7, 2017 at 10:39 am

      Yeah, that idea was around for a while. I hope more than believe it will happen. IF, it’s a big if, we get health care reform there is a good chance it’s in there. I don’t see any other way. My fingers are crossed because I love the HSA and increasing the HSA savings account amount would be sweet.

  4. Friendly Russian on June 7, 2017 at 1:43 pm

    The bad part of all of this is we can’t do anything to stop them, if they decide to increase taxes or eliminate some good ways for investment they will do it.
    But the good part is we can plan ahead and think about other options. And thanks to you for writing about it. It’s time for me to learn more about Simple 401(k) and open a small business.

    • Jack on June 10, 2017 at 6:38 am

      You could contact your congressman and voice your opinion. Sure, maybe it falls on deaf ears, but if the majority of their constituents disagreed with it, they might vote differently for fear of their jobs.

      • Keith Schroeder on June 10, 2017 at 7:30 am

        I forgot to mention that in the post, Jack. You make a powerful point. I have never been shy about calling an elected official to express my opinion.

  5. Ginny on June 7, 2017 at 8:50 pm

    Ugh. That is depressing. I hate when politicians discourage savings. My only hope is in the incompetence of the politicians to get anything passed.

  6. Peter on June 15, 2017 at 2:11 pm

    Hello Wealthy Accountant,

    I am sure you have received this question before, but is there any fear in your mind that in 20, 30 or 40 years when the US government decides they need more money, they will come up with way to tax money coming out of ROTH accounts? I am not sure if this is even possible, but I wouldn’t put it past the IRS to change the game on the way in and then to change the game again on the way out when they realize the they won’t be receiving any taxes from us “millennials” if all our retirement funds are in ROTH accounts. Just some thoughts, I am curious of your opinion.

    • Keith Schroeder on June 15, 2017 at 2:21 pm

      I don’t fear it; it is inevitable. The money in Roth IRAs will grow to a massive untaxed sum. Congress will either tax the gain (your original investment was already taxed) if your income exceeds a certain level or they will index your Social Security check to the Roth account values IMO. The future is unclear with this one, as Yoda would say. I have no idea what taxes will be decades in the future. I do know the tax code will always contain opportunities to game the system so the wealthy have an out. I will ride that train.

      Rather than worry about what might be, I focus on building a massive net worth so I don’t care what taxes are.

      • Peter on June 15, 2017 at 6:22 pm

        Sounds like a good plan, I plan to do the same. Thanks for the reply!

  7. The Frugal CPA on June 21, 2017 at 4:36 pm

    “People do not save enough already in the U.S. These proposals will take away a massive incentive to get people to start or continue to save and invest.”

    In a completely ideal world, you would have a point here. In theory, lowering your current tax liability while also allowing for your investment to grow tax free should provide the incentive for anyone to save and not only save but to max their tax-advantaged accounts. However, it’s been proven that tax-advantaged retirement accounts do very little to entice the common person to increase their savings or max their retirement accounts. What it does is subsidize the savings for high income earners, the rich, and people who would save anyway. http://www.cbpp.org/research/retirement-tax-incentives-are-ripe-for-reform

    I’m in my late 20s and I max my 401k account and contribute to my HSA as well, people in my age group and even those slightly older than me look at me like I’m crazy when I share this information. The vast majority of them have no clue about the tax benefits and/or couldn’t even tell you what type of fund their invested in with their 401k, they don’t even really understand how it works. The folks I’m talking about are all college educated and work relatively high paying jobs. I say all that to say this, decreasing the 401k deduction to $9,000 will raise tax revenue and affect savings minimally because the vast majority of Americans do not contribute $9,000 a year to their 401k. Folks like you, me, and the readers of this blog are going to continue to save and be frugal, no matter if the government subsidizes it or not.

    Lastly, this type of tax proposal will never happen, any time retirement deductions or the mortgage interest deduction are mentioned, people go straight to doom and gloom scenarios. “Oh no people won’t save anymore, oh no people will stop buying houses.” In actuality neither are true. We want the gov’t to continue to subsidize our housing costs and savings even when its proven that only 20% of us truly use these tax benefits to the fullest. I appreciate your blog as always, always good stuff.

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