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Friday, April 12, 2013

The administration views certain savings for retirement to be a tax loophole.  The just released budget, in its Overview, states:  “[The budget] ends a loophole that lets wealthy individuals circumvent contribution limits and accumulate millions in tax-preferred retirement accounts.”  [There is no acknowledgement that these dollars are subject to ordinary income tax when withdrawn nor is there an explanation of how these wealthy folks get around contribution limits which apply regardless of income.]  In the section of the budget that is titled Providing Middle Class Tax Cuts and Rebalancing the Tax Code through Tax Reform, there is a description of the President’s attack on retirement savings that states:

Prohibit Individuals from Accumulating Over $3 Million in Tax-Preferred Retirement Accounts. Individual Retirement 87767941Accounts and other tax-preferred savings vehicles are intended to help middle class families save for retirement. But 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 year in retirement, or about $3 million for someone retiring in 2013. This proposal would raise $9 billion over 10 years.

In a budget that claims to simplify the tax code, this provision, if it becomes law, is fraught with complexity and will result in reams of new regulations.  Some of the issues that would require regulation might include:

  1. In measuring an “individual’s total balance across tax-preferred accounts” are defined benefits ignored?  Nope, not according to the “Greenbook.”  (As opposed to one of these “green books“.)
  2. Since annuities are interest-rate sensitive, account balances falling under the “about $3 million” threshold would increase as interest rates rise – assuming they ever do.  How would those adjustments apply and when?
  3. What are the variables that determine an annuity of $205,000 per year?  The “Greenbook” states it’s a joint and 100% survivor annuity commencing at age 62.
  4. Does the limit apply at any time or only when someone reaches some undisclosed retirement age?  The “Greenbook” states that the determination will be made annually and by taking each account balance and converting it into an actuarial equivalent annuity (presumably for all participants).  No administrative cost there!
  5. And what happens if you go over the limit?   The “Greenbook” suggests that there will be a cessation of contributions and accruals, but earnings can continue.  However, that point underscores just how ineffective this cap is likely to be at limiting retirement savings (which is a poor goal to begin with).  In many cases, large retirement account accumulations (particularly in IRAs) are not the result of excessive contributions, but of investment of assets.  Generally speaking, at the point at which someone’s account reaches $3 million dollars, the investment return has the potential to be significantly more valuable in growing the account than additional contributions.
  6. Of course, if the limitation increased, contributions and accruals could start again.  Certainly every employer looks forward to addressing these additional administrative headaches.  And, it would seem that every American participating in both a 401(a) plan and an IRA will have to employ her own actuary.
  7. Do Roth earnings count toward the limit or is it just traditional pre-tax dollars and their earnings that count?
  8. Will the limit be indexed on some basis?

Surely there are many more issues that will need attention before this type of limitation might be implemented.  The cost of implementation by government and the private sector may even challenge the $9 billion in proposed federal savings!

An unintended consequence of such a limit may be that business owners whose own accounts could reach the limit, or who don’t want the added administrative cost, either terminate their company plans or eliminate employer contributions to those that continue in operation.  That would be detrimental to the middle class that the administration believes it is protecting.  If the idea is to put a limit on the tax-favored savings of the so-called “wealthy” [actually many may just be smart savers and investors], it is fraught with the potential to backfire and harm the middle class.  On the other hand, this may all be smoke and mirrors.  EBRI followed up the release of the budget by demonstrating that about 1% of all account holders would be affected in today’s interest environment.  However, EBRI points out that the threshold would decrease dramatically, cover many more accounts and have the most significant impact on the younger generations as time goes by.  But if so few are impacted, why would any employer want the additional headache?  And will the DOL let the plan pay for this – probably not – after all, it only affects the wealthy, right?

Best of all, this is intended to go into effect for taxable years beginning January 1, 2014 – if it becomes law.

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