'Backdoor' Roth restrictions have been put on hold -- for now

If you're a high earner who was scrambling to take advantage of a so-called backdoor Roth IRA or Roth 401(k) before new rules go into effect prohibiting you to do so, you just got a reprieve.

Senator Joe Manchin's refusal to vote for the Build Back Better bill puts the future of that legislation in jeopardy. And, as a result, it also puts in jeopardy a revenue-raising provision in the bill that would restrict the ability of high-income savers to put money into Roth IRAs and Roth 401(k)s using a backdoor conversion method.

The main advantage of Roths is the ability to invest after-tax contributions that will both grow tax-free and be withdrawn tax-free. It's a good option if you expect to be in a higher tax bracket in retirement or if you want greater flexibility to decide when to tap different pots of money for different purposes in retirement or at any other point.

Under current law, if your modified adjusted gross income is $140,000 or more ($208,000 if married filing jointly) you can't contribute directly to a Roth IRA in 2021. And if you are covered by a retirement plan at work and your income is $76,000 or more ($125,000 if married), you're not allowed to make deductible contributions to a traditional IRA either.

But you can still put money into a Roth IRA by using a "backdoor" strategy of converting your after-tax contributions to a non-deductible IRA. Annual contributions to IRAs are capped at $6,000 ($7,000 if you're 50 or older).

With a Roth 401(k), the current rules are much more liberal. There are no income restrictions and the federal cap on annual contributions is much higher than it is for Roth IRAs. So very high-income earners can sock away tens of thousands of dollars a year in a Roth 401(k) -- both directly and also by using a "mega backdoor" strategy that lets them convert both their pre- and after-tax savings from their workplace plans so long as they pay the taxes owed on the conversion.

But a provision included in the Build Back Better bill would prohibit taxpayers of all income levels from converting after-tax savings into a Roth IRA or a Roth 401(k) starting next year. Then a decade later, the door would shut entirely on high-income earners contributing to Roths.

Dead for now, but not necessarily forever

When it comes to revenue-raising provisions to help pay for lawmakers' big initiatives, never assume they are killed off for good even if a given bill doesn't become law.

And don't assume a modified version of the Build Back Better bill may not come to pass at some point next year.

The question is when might restrictions on backdoor Roths go into effect?

No one can say for sure, but if a version of the BBB bill does pass next year, it's more likely than not that the effective date -- at least for the Roth 401(k) restrictions -- might get pushed to 2023.

"All 401(k) plans require that employees elect how much to defer into the pre-tax or the Roth portion before the income is earned. I don't see how Congress could make a change in the use of Roth 401(k)s retroactive [to January 1, 2022]," said California-based certified public accountant Mary Kay Foss.

Given all the uncertainty, Foss said, "my advice would be to keep doing what you've been doing and hope for the best."