President Obama recently unveiled his proposed budget for 2015. Included in the proposal were the following potential changes to investor retirement accounts:
Apply Required Minimum Distribution Rule To Roth IRAs
There are currently two main reasons to invest in a Roth IRA – to pay taxes at your current rate in anticipation of being in a higher tax bracket in the future, and to invest in an account that does not require minimum distributions when the investor reaches age 70½. However, President Obama’s 2015 budget calls for Roth accounts to be subject to the same RMD rules as other retirement accounts.
This change would make Roth IRA accounts much less appealing for a good portion of the investment community. Additionally, the rule would dramatically reduce the benefit for many individuals to convert their traditional retirement accounts to Roth accounts. Lastly, this rule would essentially betray all investors who already converted their accounts to Roths by taking away a benefit they were counting on.
Eliminate Stretch IRA
Non-spouse beneficiaries of retirement accounts currently have the option of either withdrawing the funds from the retirement account within five years of the original IRA owner’s death or stretching IRA distributions over their expected lifetime. Obama’s proposal would eliminate non-spouse beneficiaries’ ability to stretch distributions over a period of more than five years.
If implemented, this change would have severe tax implications on people inheriting a retirement account and drastically reduce the value of tax-deferred accounts as estate planning tools.
Cap on Tax Benefit for Retirement Account Contributions
Currently, investors obtain a full tax-deferral benefit on all contributions to retirement accounts. Under Obama’s proposal, the maximum tax benefit that would be allowed on retirement contributions would be 28%. Consequently, an investor in the 39.6% tax bracket would only be able to deduct 28% and would still need to pay taxes at 11.6% (39.6% - 28%) on all contributions made.
Eliminate RMDs For Retirement Accounts Less Than $100k
Quite simply, individuals whose retirement accounts have a total value of less than $100k would no longer be subject to required minimum distribution rules. This would enable retirees with less in their retirement accounts to take greater advantage of the tax-deferral benefit an IRA provides.
Retirement Account Value Capping New Contributions
Under the new proposal, once an individuals’ retirement account value grew to a certain cap, no further contributions would be allowed. This cap would be determined by calculating the lump-sum payment that would be required to produce a joint and 100% survivor annuity of $210,000 starting when the investor turns 62. Currently, this formula would indicate a cap of $3.2 million. This cap would be adjusted for inflation.
Proposal, Not Law…
Keep in mind that these potential changes are currently just proposals and are not certain to be implemented into law. In fact, with the exception of RMDs for Roth accounts, all of these suggested adjustments were proposed by Obama last year and none were approved by congress. Consequently, history suggests that Obama may have a hard time getting these changes implemented. Still, examining the proposals provides some insight into the direction President Obama would like to proceed.