We have received several
calls on the proposed $3 million cap on 401(k)s and IRAs. Some of those discussions have been spirited.
What is it? Equally
important, what is it not?
The proposal comes from the White
House budget. Here is some text:
The
budget will also show how we can provide targeted tax relief to strengthen the
economy, help middle class families and small business and pay for it by
eliminating tax loopholes and make the tax system more fair. The budget will
include a new proposal that prohibits individuals from accumulating over $3 million
in IRAs and other tax-preferred retirement accounts. Under current rules, some
wealthy individuals are able to accumulate many millions of dollars in these
accounts, substantially more than is needed to fund reasonable levels of
retirement saving. The budget would limit an individual’s total balance across
tax-preferred accounts to an amount sufficient to finance an annuity of not
more than $205,000 per person per year in retirement, or about $3 million in 2013."
Let us
point out several things:
(1)
The proposal
would not force monies out of an existing retirement plan. It would instead
prevent new monies going into a plan.
This raises a question:
should one draw enough to reduce the balance below $3 million, would one be
able to again contribute to the plan?
(2)
The proposal uses
the term tax “preferred” rather than tax “deferred.” This indicates that the proposal would reach
Roth IRAs. Roth IRAs are not tax deferred, as there is no tax when the funds
come out. They instead are tax “preferred.”
There is some rhyme or reason
to this proposal. $205,000 is the current IRC Section 415 limit on funding
defined benefit (think pension) plans. The idea here is that the maximum tax deduction
the IRS will allow is an amount actuarially necessary to fund today a pension
of $205,000 sometime down the road. The closer one is to retirement, the higher
the Section 415 amount. The farther one is, the lower the Section 415 amount. This
proposal is somewhat aligning limits on contribution plans with existing limits
on benefit plans.
(3)
The $3 million is
an arbitrary number, and presumably it would change as interest rates and
actuarial life expectancies change over time. If longevity continues to
increase, for example, the $3 million may be woefully inadequate. Some planners
consider it inadequate right now, at least if one is trying to secure that $205,000
annual annuity.
(4)
Would the annuity
amount increase with inflation? Assuming an average inflation rate of 4.5
percent, one would lose almost three-quarters of a fixed annuity’s purchasing
power over 30 years.
The frustrating thing about
the proposal is that it affects very few people. The Employee Benefit Research
Institute estimates that only 1% of investors have enough to be subject to this
rule. This of course feeds into the perceived anti-success, anti-wealth meme of
this White House.
(5)
The amount of
money to be raised over a decade is also chump change for the federal government: less than $10 billion.
Something to remember is that
account balances in 401(k), SEP, SIMPLE and regular IRA accounts will be
taxable eventually. IRAs are subject to minimum distribution rules, for
example. The larger the balances, the more the government will take in taxes. Dying
will not make the tax go away. In fact, it may serve to accelerate required
distributions to a beneficiary and taxes to the government.
The budget was dead on
arrival at Capitol Hill. Let us hope that less ideologically rigid minds on the
Hill keep it so.
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