Three proposals being debated on Capitol Hill would limit many investors’ ability to plan for retirement.
As Washington lawmakers grapple with the federal budget deficit, some retirement accounts and provisions have come under scrutiny. Here are three proposals that have been introduced:
1. Scale back retirement plan contributions
Originally proposed in the 2010 Simpson-Bowles Commission report, this proposal would reduce the maximum contribution amount for IRAs and defined-contribution plans. Currently, DC plan participants may contribute more than $50,000 through salary deferrals, employer matching, and profit-sharing contributions. Proponents of new limits view these tax-deferred contributions as a source of needed tax revenue. The proposal calls for consolidating retirement accounts and setting the limit on total contributions to the lower of $20,000, or 20% of income.
2. Limit savings accumulation within retirement plans
The White House presented a proposal to cap the amount of retirement savings that can be accumulated by individuals. In President Obama’s fiscal-year 2014 budget, the proposal would limit an individual’s total balance across tax-preferred accounts (401(k)s and IRAs) to an amount sufficient to finance an annuity of not more than $205,000 per year in retirement, or equivalent to about $3 million in retirement savings for an individual retiring in 2013. Those with accounts greater than the threshold would be unable to make additional contributions and would be required to withdraw excess funds from retirement accounts and report those distributions as ordinary income.
3. Introduce restrictions to “stretch IRA” distributions
The ability to extend the life of an Individual Retirement Account (IRA) for successor beneficiaries has come under scrutiny in the budget debate. Included as part of legislation to preserve interest rates for certain federal student loan programs (S.953 “Student Loan Affordability Act”), this provision would require a non-spouse beneficiary to withdraw funds from an IRA within five years following the death of the account owner. Under current tax laws, non-spouse beneficiaries are required to take distributions from inherited IRAs, but they have the option of calculating those distributions based on their remaining life expectancy. To the extent that the beneficiary is younger than the IRA owner, this stretch IRA strategy allows the account to continue to grow tax deferred after the death of the account owner.
While it is impossible to predict the future of these types of tax reform proposals, it is important for clients to understand the legislative risks surrounding retirement savings. Clients may want to take advantage of opportunities to plan for retirement and benefit from the current tax advantages associated with many of these investment accounts.
A discussion of the budget debate on Capitol Hill presents an opportunity for advisors and clients to review retirement savings and planning needs.