Proposed IRA Changes in the Obama Federal Budget

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Reviewing Potential IRA Changes 

Rick Kahler MS CFP

By Rick Kahler CFP® http://www.KahlerFinancial.com

The President has fired the first warning shot indicating that politicians are eying the tax advantages of the Roth IRA. For years I’ve strongly encouraged maximum funding of Roth IRAs & 401(k)s.

Physician-Clients have sometimes expressed concern that politicians would someday retroactively change the rules and strip the plans of their tax advantages. I’ve seen that concern as a possibility (for example, in 2008 Argentina confiscated the assets in IRAs and 401(k)s and replaced them with less than desirable Argentinian Government Bonds), but not much of a probability. 

With the introduction of the President’s 2016 budget, the probability of losing some Roth IRA tax benefits has increased.  

Each February the President submits a budget to Congress which is about far more than spending requests. It also contains scores of proposed changes to existing tax laws. One such proposal in the current budget would eliminate two tax advantages of the Roth IRA.  

The first change would require required minimum distributions (RMDs) for Roth IRAs as well as traditional IRAs.  

Currently, one of the benefits of a Roth IRA is not having to take RMDs. At age 70 1/2, owners of traditional IRAs are required withdraw a certain percentage annually, often around 4%. They must pay the tax due and, if they don’t need the funds for living expenses, must invest the remainder in a taxable account. The RMD denies them the option of leaving the money in the tax-deferred environment of the IRA and further compounding.  

Under the President’s proposal, owners of Roth IRAs will need to start withdrawing funds annually at age 70 1/2. While there won’t be any taxes due because contributions to Roths are post-tax, it will remove the funds from the tax-free environment, decreasing future returns by up to 40%. That’s a big deal. 

The second proposed change would eliminate tax-deferred inheritance of IRAs (sometimes called “stretch IRAs) for anyone except spouses. All other inherited IRAs would need to be dissolved and the funds distributed and taxed within five years after death. This will really impact Baby Boomers counting on their parents’ IRAs to assist them with their own retirement needs. 

Other budget proposals would also end Roth conversions to any after-tax IRAs, limiting them to IRAs where the contributions were before taxes. This would prohibit taxpayers with earnings above the traditional and Roth IRA threshold from making non-deductible contributions to a traditional IRA and then doing a Roth conversion. 

The final proposal would limit new IRA contributions for total retirement savings totaling over $3.4 million. This includes the aggregate total of IRAs, 401(k)s, and any other pension plan balances. Once the total reaches $3.4 million at the end of the tax year, no new contributions are possible. 

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Capping IRA Growth?

To many Americans, especially the youth, this looks like a cap they will never see in their lifetime. Yet consider what $3.4 million will be worth in purchasing power 40 years from now, when today’s 30-year-olds will have to start RMDs. If inflation maintains its historical average of 3%, in 40 years $3.4 million will have the purchasing power of just over $1 million today. If someone wants to be assured they will never run out of money in retirement, $1 million only provides $30,000 a year of retirement income.

Capping IRA growth is another big deal.

Assessment 

These are a few of the tax changes proposed by the President’s budget. The chances for any to become law in 2016 are remote, given that Congress is currently controlled by Republicans. However, the proposals do signal the current thinking of lawmakers. In considering their retirement planning, taxpayers would be advised to pay attention to such signals.

Conclusion

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2 Responses

  1. HERE’S A MILESTONE YOU DON’T REACH UNTIL YOUR SEVENTIES

    The major milestones of older Americans are not attended with the same sense of wonder that accompanies the major milestones of younger Americans. Sure, registering for Social Security benefits and signing up for Medicare are rites of passage, but they don’t hold a candle to earning your driver’s license, receiving your first kiss, winning your first promotion, or dancing at your wedding.

    If you have retirement accounts when you become a septuagenarian, then you’ll encounter a milestone the Internal Revenue Service (IRS) strongly encourages you to remember. Beginning April 1 of the year following the year in which you reach age 70½, you must begin taking required minimum distributions (RMDs) from most of your retirement accounts. Forbes offered this list:

    • Traditional IRAs
    • Rollover IRAs
    • Inherited IRAs
    • SEP IRAs
    • SIMPLE IRAs
    • 401(k), 403(b), and 457(b) plan accounts
    • Keogh plans

    There currently are no RMDs for Roth IRAs, unless the accounts were inherited.

    If you have more than one qualifying retirement account, then a separate RMD must be calculated for each account. If you want to withdraw a portion of each account, you can, but it may prove simpler to take the entire amount due from a single account. Once you start, you must take RMDs by December 31 every year. If you don’t, you’ll owe some hefty penalty taxes.

    The IRS offers some instructions for calculating the RMD due.

    “The required minimum distribution for any year is the account balance as of the end of the immediately preceding calendar year divided by a distribution period from the IRS’ “Uniform Lifetime Table.” A separate table is used if the sole beneficiary is the owner’s spouse who is ten or more years younger than the owner.”

    If you would prefer to have some help figuring out the correct amount when RMDs are due, contact your financial professional.

    Arthur Chalekian GEPC
    [Financial Consultant]

    Like

  2. UPDATE: myRA

    If myRA, President Obama’s signature retirement plan, were a private-sector startup, it would probably be getting some heat from its venture capital backers right about now.

    Two years after the president used his State of the Union speech to direct the Treasury Department to “create a new way for working Americans to start their own retirement savings plan” and a year after its national rollout, the myRA program has a long way to go to help the millions of Americans that a White House blog about the program envisions.

    https://www.bloomberg.com/news/articles/2016-12-16/obama-s-myra-retirement-plan-starts-off-with-a-whimper

    The tally: 20,000 myRA accounts have been opened, with assets of about $17 million.

    Kinchfield

    Like

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