While the upcoming budget talks will, more than likely, have very few tangible effects on the average citizen, there is one area to keep a close eye on this fall. Obama’s budget proposal a few months ago included some new retirement plan rules and if enacted could have an immediate consequence for many. Among the proposed changes is the stretch IRA meant to allow the children (primarily) of the deceased to take payments from this savings over a lifetime. In other words, a parent could provide a lifetime income similar to an annuity, to their kids. The reason Obama and others hate this provision is that it allows the children to avoid taxes on the IRA except for the annual payments. All of that money is sheltered from the governments reach until withdrawn and well, they want their money:
But the president is proposing that beneficiaries must empty the inherited IRA by the end of the fifth year after the year of the original owner’s death.
If they have to withdraw more money each year, beneficiaries, of course, would face bigger tax bills and the government would collect more revenue.
While it may be true that in theory, republicans will oppose this proposal, it is also true that the retirement plan market can be a way to get “revenue” in a relatively painless manner. Among Obama’s other proposal is one that caps the amount allowed to accumulate in a 401K rollover or even a regular IRA. Because of contribution limits though, the reality is that this rule will only hit people with IRA’s that are based on money originally from a 401K (or other retirement vehicle). The proposal uses a formula that caps the money at about $200,000 in available income, not assets. So, if your IRA could, based on current interest rates generate that kind of income it would then be capped off and anything above that asset level would be taxed. Now, currently, with rates so low that is a sizeable IRA (approximately $3 million).
Of course, both of the above examples would hit very few, percentage wise at least, and therefore may be extremely tempting for lawmakers. The truth is most children, even seasoned adults, cannot afford to take lifetime payments from an inherited IRA. Or, to be even more precise they often don’t want to even if they could. Except for the very well off, a yearly lifetime payment of say, $6,000 a year versus a lump sum of $200, 000 is difficult to accept. While the long term math may work in their favor, the temptation to pay down debt like a mortgage or be able to send their children to college is just too great. And it’s for these reasons that Obama feels this is an area for easy pickings. The danger, of course is that this is a well that is just too great to resist even for Congress. These are rules that are mostly unknown to the average IRA owner let alone the average citizen. But even some of the more obscure changes to retirement plans will have reverberations:
Congress and President Obama are expected to square off in coming months over possible changes in how individual retirement accounts and 401(k)s work. The administration’s proposals, if adopted, could fundamentally alter retirement finances – and the tax landscape – in the U.S.
That is true and that is assuming that only “the rich” are targeted. If revenue becomes a sticking point, and Obama has said unequivocally that it most certainly will, then retirement plans could be prime targets. It fits into the type of tax increases that republicans have supported in the past. Basically under the radar taxes (or “loopholes” — a favorite Washington term). But there are more rules involved and undoubtedly more to be suggested regarding your savings. So, keep an eye out for any budget negotiation shenanigans, as always. The retirement plan cookie jar may just be too big for congress to resist.