But advisors should pay close attention to the eventual compromise because there were a number of significant proposals related to retirement savings accounts.
Here is an overview of six notable proposals and whether your clients would be winners or losers.
1. MANDATORY IRAs
Under the administration’s proposal, employers that have more than 10 workers and have been in business for at least two years would face a new requirement to set up and provide automatic enrollment in IRAs for their employees. Employees would contribute to the IRAs through payroll deductions. In addition, they would be able to elect how much of their salary they wish to contribute to their IRAs (up to the annual contribution limit), or they could elect to opt out.
In the absence of any election, 3% of an employee’s salary would be contributed to the IRA.
The argument: For nearly 15 years,
The winners: Too few Americans actively save for retirement, and even fewer save appropriate amounts. Although there is some disagreement, numerous studies have shown that automatic enrollment tends to increase participation in retirement savings. The proposal also contains a number of tax credits that small businesses could claim for helping to facilitate employees’ retirement savings.
The losers: Many small businesses say that they are already overburdened with various compliance requirements and that any new rules or regulations would be unwelcome.
2. EMPTYING INHERITED IRAs
Most beneficiaries of IRAs and other retirement accounts would be required to empty an inherited retirement account by the end of the fifth year after the year of the original owner’s death, according to the administration proposal. (Presumably, required minimum distribution rules would apply, meaning the remaining balance would be subject to a 50% penalty — like all other missed required minimum distributions.)
This proposal is a potential game changer for many clients’ estate plans. But this is not the first time the idea has been floated. In fact, since Sen.
The argument: The Green Book, released by the
This point has been brought up a number of times when lawmakers are looking for revenue sources, which is happening again now. Some in
The winners: The required minimum distribution rules for non-spouse beneficiaries can be complex. Requiring non-spouse beneficiaries to withdraw inherited retirement account funds within five years would simplify the rules. The proposal exempts certain beneficiaries, including those who are disabled and minor children.
The losers: If this proposal is adopted, it would effectively end the “stretch IRA” strategy for most non-spouse beneficiaries. Beneficiaries would face more severe tax consequences upon inheriting retirement accounts, and the value of these accounts as potential estate planning vehicles would be diminished. This would also significantly reduce the value of Roth conversions as an estate planning strategy, particularly for older clients.
3. SAVINGS CAP
New contributions to tax-favored IRAs and 401(k)s would be prohibited once clients exceed an established cap, under the president’s proposal. This cap would be determined by calculating the lump-sum payment that would be required to produce a joint and 100% survivor annuity of
Clients with cumulative retirement accounts in excess of this amount would be prohibited from contributing new dollars to retirement accounts on a tax-favored basis, although accounts could still grow as a result of earnings. The cap would be increased for inflation.
The argument: To increase tax revenue, the
The winners: Not many. In fact, at
The losers: While
4. A 28% MAXIMUM TAX BENEFIT
Another proposed change to tax benefits: The maximum tax deduction for making contributions to defined contribution retirement plans would be limited to 28%. As a result, certain high-income taxpayers making contributions to retirement accounts would not receive a full tax deduction for amounts contributed or deferred.
The argument: According to the Green Book, “limiting the value of tax expenditures, including itemized deductions, certain exclusions in income subject to tax, and certain deductions in the computation of adjusted gross income would reduce the benefit that high-income taxpayers receive from those tax expenditures and help close the gap between the value of these tax expenditures for high-income Americans and the value for middle-class Americans.”
The winners: For the country as a whole, this provision would help raise revenue. For individual taxpayers who are not in a federal income tax bracket higher than 28%, this provision would not increase their tax liabilities.
The losers: High-income clients would no longer receive a full deduction for amounts contributed or deferred to a retirement account. For instance: If clients who have
5. SOME RMD ELIMINATION
Clients with combined savings across all retirement accounts of
The argument: “Under current law,” the Green Book says, “millions of senior citizens with only modest tax-favored retirement benefits to fall back on during retirement also must calculate the annual amount of their minimum required distributions, even though they are highly unlikely to try to defer withdrawal and taxation of these benefits for estate planning purposes. In addition to simplifying tax compliance for these individuals, the proposal permits them greater flexibility in determining when and how rapidly to draw down their limited retirement savings.”
The winners: The proposal would decrease the compliance burden and increase simplicity for Americans with smaller retirement account balances. These individuals often have less savings on the whole and need to withdraw money from their retirement accounts anyway to meet expenses. In addition, those with low account balances often do not have access to the same level of financial expertise as those with larger account balances.
The losers: Not many. Indeed, it’s hard to find something to complain about. This provision would eliminate required minimum distributions for nearly 50% of IRA owners.
6. NON-SPOUSE ROLLOVERS
Non-spouse beneficiaries would be allowed to move inherited retirement savings from one inherited retirement account to another through a 60-day rollover period — similar to the way they can currently move their own retirement savings.
The argument: The goal is to close the difference in treatment of spouse and non-spouse beneficiaries. According to the Green Book, “differences in rollover eligibility between surviving non-spouse beneficiaries and surviving spouse beneficiaries (and living participants) serve little purpose and generate confusion among plan and IRA administrators and beneficiaries.”
The winners: Unifying the rollover rules for retirement account owners and beneficiaries would greatly simplify this aspect of retirement accounts and reduce the number of irrevocable and costly mistakes frequently made by beneficiaries.
The losers: None. Of course, if most beneficiaries are required to empty the inherited account in five years (as required under the second proposal), this provision would be far less beneficial than it would be under current law. FP
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