New Presidential Budget:
How It Affects You!
The President released his budget for FY 2014. While there are many proposals in the budget, including a proposal expanding child and dependent care tax credits and one increasing contributions by Federal workers for their pensions, we have included a few (but not all) proposals that are relevant to retirement and estate planning. The proposal is listed with explanations from the President's plan. We have provided comments that are labeled with Money Education Comment, thanks to the publisher of many of our textbooks – Money Education .
President's Proposal: Prohibit Individuals from Accumulating Over $3 Million in Tax-Preferred Retirement Accounts
Individual Retirement Accounts and other tax-preferred savings vehicles are intended to help middle class families save for retirement. But under current rules, some wealthy individuals are able to accumulate many millions of dollars in these accounts, substantially more than is needed to fund reasonable levels of retirement saving. The Budget would limit an individual's total balance across tax-preferred accounts to an amount sufficient to finance an annuity of not more than $205,000 per year in retirement, or about $3 million for someone retiring in 2013. This proposal would raise $9 billion over 10 years.
The Treasury explanations provide this reason for the change: "Requiring a taxpayer who, in the aggregate, has accumulated very large amounts within the tax favored retirement system to discontinue adding to those accumulations would reduce the deficit, make the income tax system more progressive and distribute the cost of government more fairly among taxpayers of various income levels while still providing substantial tax incentives for reasonable levels of retirement saving."
Money Education Comment: This proposal appears to be simply a method of accelerating future tax revenue for the current administration since all funds in tax-deferred accounts are subject to income tax upon distributed. These acceleration techniques have certainly been used by all administrations in the past. We ran a couple of quick time value of money calculations - TVM calculation #1: a 25-year-old who saves $5,000 each year until he is age 65 and earns an annualized rate of return of 12% would have a balance of $3.8 million. The annual contribution limit for IRAs and 401(k) plans is currently $5,500 and $17,500, respectively. TVM calculation #2: a $3 million lump-sum will produce a $205,000 annuity for approximately 18 years using a 2% real return. However, half the population that attains age 65 will likely live beyond 18 years. Additionally, this proposal is targeted at defined contribution type plans and does not attempt to equate pension annuities from defined benefit plans. A proposal like this might ignite opportunities to establish more defined benefit and cash balance plans for small businesses that have sufficient cash flow in lieu of other defined contribution plans.
President's Proposal: Encourage Retirement Savings with Automatic Individual Retirement Accounts and Support for Small Employers Who Offer Retirement Plans.
About half of American workers have no workplace retirement plan. Yet fewer than 1 out of 10 workers who are eligible to make tax-favored contributions to an Individual Retirement Account (IRA) actually do so, while nearly 9 out of 10 workers automatically enrolled in a 401(k) plan continue to make contributions. The Budget would automatically enroll workers without employer-based retirement plans in IRAs through payroll deposit contributions at their workplace. The contributions would be voluntary-employees would be free to opt out-and matched by the Saver's Tax Credit for eligible families. Small employers would be eligible for tax credits to defray the administrative costs of setting up these savings plans. The Budget would also double the existing tax credit for small employers that start up new qualifying employer plans.
Money Education Comment: Below is a summary of the access and participation rates in retirement plans for employees in private industry and state and local government. While it appears that the comment regarding "half of Americans" is not entirely accurate, the issue is sound and the idea of encouraging savings is certainly a good one. However, if this proposal involves additional "compliance" issues, small businesses will not likely be huge fans. Reading the Treasury explanation provides a bit more information: employers that currently sponsor a retirement plan would not have to comply and employers with 10 or fewer employees would be exempt.
President's Proposal: Return Estate Tax to 2009 Parameters and Close Estate Tax Loopholes
The Budget returns the estate tax exemption and rates to 2009 levels beginning in 2018. Under 2009 law, only the wealthiest 3 in 1,000 people who die would owe any estate tax. As part of the end-of-year "fiscal cliff" agreement, congressional Republicans insisted on permanently cutting the estate tax below those levels, providing tax cuts averaging $1 million per estate to the very wealthiest Americans. It would also eliminate a number of loopholes that currently allow wealthy individuals to use sophisticated tax planning to reduce their estate tax liability. These proposals would raise $79 billion over 10 years.
Money Education Comment: It is unclear from the proposal what is meant by "sophisticated tax planning." However, much of the "sophisticated tax planning" that we are familiar with generally requires diluting ownership of assets or is based on generally accepted, as well as court accepted, valuation methods. It should be noted that the Treasury explanation also provides a proposal for GRAT terms to be at least 10 years. It should also be noted that as tax rates increase, there is more of an incentive to develop and implement "sophisticated tax planning" techniques. For example, when capital gains rates were higher in the 1990s, there was more planning done to shelter gains from the sale of businesses. This planning was reduced in the 2000s when rates were lower.
President's Proposal: Require Nonspouse Beneficiaries Of Deceased Individual Retirement Account Or Annuity (Ira) Owners And Retirement Plan Participants To Take Inherited Distributions Over No More Than Five Years
The Treasury explanations provide as a reason for the change is that the "Internal Revenue Code gives tax preferences for retirement savings accounts primarily to provide retirement security for individuals and their spouses. The preferences were not created with the intent of providing tax preferences to the nonspouse heirs of individuals. Because the beneficiary of an inherited account can be much younger than a plan participant or IRA owner, the current rules allowing such a beneficiary to stretch the receipt of distributions over many years permit the beneficiary to enjoy tax favored accumulation of earnings over long periods of time.
Money Education Comment: As with the $3 million accumulation proposal, this appears to simply be a way to accelerate tax revenue that would naturally occur in the future. As stated above, all administrations (Republican and Democrat both) do this. Historically, there have been unintended consequences to some changes in tax rules. This proposal has the potential of providing a disincentive to saving in tax sheltered accounts, which is inconsistent with the proposal to encourage saving outlined above. It should be noted that as of the end of 2012, there was $19.5 Trillion in private and public deferred accounts according to the Investment Company Institute.
Money Education Conclusion: With the gridlock in Washington, it seems unlikely that any of these proposals will make it in a final bill or if we will even have a budget that passes the House and the Senate. However, it is important to understand some of the proposals and thinking in Washington.