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Proposed Retirement Cap: More People Could Be Affected Down the Road

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Stop SignOne of the more controversial (at least in financial circles) items to come out of the budget recently proposed by the Obama Administration is a cap on retirement accounts.

The idea is to cap retirement accounts, preventing further contributions to tax-advantaged accounts. The reasoning is that, at a certain level, enough is saved up for a “reasonable” retirement and there is no more need for the tax advantage.

Presumably, instead of contributing to tax-deferred accounts, those who reached the cap would no longer be able to take advantage of the savings, and pay taxes on that income, instead of getting a tax deduction. (Of course, there are issues surrounding the fact that, eventually, taxes would have been collected on the money if it were withdrawn from a tax-deferred account down the road.)

Who Would the Cap Affect?

Rather than being a hard dollar amount, this cap is a fluctuating cap. The cap is based on the lump sum it would take to create a return of $205,000 a year if the money were placed in an annuity. Today, according to the EBRI, that means about 0.06 percent of IRA accounts and 0.0041 percent of 401(k) accounts would be affected.

However, accounts affected could increase in the future. Annuity returns could rise if interest rates start going up. At this point, the cap would drop. The EBRI used 2006 interest rate levels to determine that the cap could drop to $2.2 million, affecting three percent of 401(k) accounts. And, if interest rates rose even higher than 2006 levels, the cap would drop further, meaning that more people would be affected.

Some argue that the cap would result in fewer plans being offered by employers. They cite the administrative problems associated with delineating between accounts subject to the cap and those that aren’t subject to the cap. “Put a cap on it and you take away an incentive for owners to offer a plan,” says Ilene Davis, a Certified Financial Planner with an MBA.

What Can You Do?

Of course, most of us don’t have $3 million in our accounts right now. And some of us won’t even reach $2.2 million by retirement. So the impact would likely be minimal. But what if you were going to be affected? What if rates went high enough that the cap dropped to $1.5 million?

It depends on what you think you will need to live on in retirement, as well as what you plan to do with the money. If you are concerned that your employer will stop offering a plan, you can still open an IRA. You can even start your own business and make larger contributions to a solo 401(k) or to one of the IRAs aimed directly at business owners.

Davis suggests that business owners take a different route. “Just put money into a tax-deferred annuity,” she says. “Same general benefits, but this gets away from the accounting fees, government rules, and cost. That is what I would advise for business owners if a cap was put into place.”

It looks as though how you will be affected, and what you can do, depends a great deal on whether or not you are a business owner or an employee.

What do you think of the cap? Do you think it’s a good idea? Or a bad idea?

Image: thecrazyfilmgirl

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19 Responses to “Proposed Retirement Cap: More People Could Be Affected Down the Road”

  1. Christian L. says:

    Miranda,
    I wrote about this topic for Under30Finance. I simply don’t see this passing because the language is too vague. The EBRI was far more thorough than the proposal’s author.

    I’m more bothered by the principle of the matter, but I doubt retirement accounts will start getting taxed in the next five years.

    -Christian L. @ Smart Military Money

  2. It’s yet another way to punish people who provide for themselves and to encourage people to be dependent on the government.

    Needless to say, I am NOT in favor.

  3. ChrisCD says:

    It just doesn’t make sense. At some point, the funds would be subject to Taxes. As with Jenny, why punish people who put money away?

    And why tie it to annuity returns? Did the insurance industry write this part of the proposal?

    The savers aren’t the people who caused any of the current economic problems. But once again, the Gov’t seems bent on punishing them.

  4. I wonder how many people this would effect? It sounds like these people would be making a lot of money any way.

  5. freeby50 says:

    Most tax rules have limits and this is just another such limit. Most often the tax breaks do not apply for the multi-millionaires since we have a progressive system. The current proposed limit of $3m is a lot of money. As the ERBI said only 0.06% of accounts would be impacted. I fail to see a problem here. This is really no different than all the other limits on tax breaks.

  6. admiral58 says:

    Only in Obama’s world can being a responsible and sensible individual can have a downfall.

  7. David Stein says:

    Lousy idea. If they want to raise revenue, they should reduce the quirks in the tax code that allow highly compensated workers to defer $45,000 per year in 401k and profit sharing plans while the rest of the employees are stuck with much lower limits.

    That and start taxing hedge fund and private equity carried interest (i.e. their percent of profits) as earned income instead of capital gains. That is where there is a huge degree of unfairness.

  8. NateUVM says:

    Certainly no one likes paying more taxes. So, unfortunately, we all have a standing bias against this proposal. Can we be objective…? Let’s try to look at this a slightly different way…

    People should be saving already. Without tax incentive. They should already be making sure that they have enough to retire and not be a burden on the rest of society. There should not be a tax incentive to motivate people to do that.

    That being said, there IS a tax incentive to saving for retirement. Why? Because, without incentive, not everyone DOES save enough for retirement. And policy makers decided it was worth the impact to the tax base to create enough incentive to prevent, as much as they could, more people being in need in their retirement years.

    So, why should that incentive remain once someone has reached a level of savings that would prevent their being in need in those years (wherever it’s decided that line is)? It’s not “punishing those that already save,” it’s taking the carrot away from those that needed the push in the first place.

    For those that are worried about balancing the budget, this is a no-brainer, common-sense step that can be taken. As a nation, we cannot afford to subsidize people’s retirement savings once they have “enough.” Beyond that point, if people want to save more, people need to realize that the benefit of saving should be more than enough incentive, on its own.

  9. I understand, to a certain extent, why they want this, but I am opposed to it purely off of principle. If something like this gets passed then we give it all up. What’s to stop the government from continuing to decrease the cap?

  10. Matt Becker says:

    I honestly don’t have a problem with the concept. There’s nothing huge and unfair happening here. You can still save money, just not in a tax-advantaged space. But what I think will have a bigger impact on whether this starts affecting more people is how they adjust the $205,000 number. If that doesn’t get adjusted, it will turn out like the AMT and affect more and more people. If that tracks inflation, then I don’t think interest rates will end up affecting to big a piece of the population.

  11. bloodbath says:

    The cap is discouraging and bogus. It has cost me over $15000 so far. Millionaires are less affected than born-poor people like me who has worked hard to lift our offspring out of poverty. I’ve had to find ways to increase our ‘wealth’ without 401k savings and it pisses me off!

  12. Chris Dowling says:

    Seems rather trivial, given the small number of accounts potentially affected. Also, ISTM the multiple tax favored accounts available would make this more complex (traditional IRA, Roth IRA, SEP, Roth 401k, etc..)

  13. JoeTaxpayer says:

    First – Ironic that this cap, [which articles written] cited Romney’s large IRA as its inspiration, simply stops his deposits, his $200M IRA stays in place, as it.

    You hit the next issue dead on – it’s not a simple inflation-adjusted number. The $3M can drop like a rock as rates rise. This makes for a tough time planning, as you’d not know if you’re impacted until the exact number are announced, and the burden would be on Washington to announce the number with time to spare so you can advise your employer whether you can make deposits.

    Next, since, last I checked, your employer does talk to Schwab about your IRA, it’s for the taxpayer to aggregate their accounts and advise the current employer regarding the deposits for the year to come.

    For those right at the limit, they’ll have a tough choice ahead – make a withdrawal to leave room for a matched deposit, forgo the deposit, or wait to get caught and deal with the penalty which presumably will be worse than a simple 10% plus tax.

    (Last) – I can see some strange consequences from this. A high earning spouse hitting $3M with the other not working. A quick divorce and QDRO to split the retirement accounts. A new marriage in the new year. Strange? Wait and see.

  14. Dennis says:

    This idea is a lousy. Again, the government is telling you “how much is enough”, how you should save and where”?
    Saving must be encouraged in any way possible. Why? Do you really think that Social Security will be there in 2027? Honestly? This system will most likely be bankrupt before then due to other governmental issues….11 million new undocumented persons added to benefits agenda. My children will never see Social Security !
    Save-Save-Save You are responsible for your future, not the government.

  15. When I first read the title of this article, I had a shiver of fear – Oh No! I won’t be able to have the advantages of our retirement benefits?!?

    However, looking at the numbers, capped IF the retirement account makes OVER $205,000 per year for us? I can only strive for that kind of return – and a lifestyle of passive income of $205,000 per year!

    Currently, our entire passive income portfolio consisting mainly of real estate rentals gives an annual return of $36,000. Not too shabby, but a long way away from and annual return of $205,000.

    I honestly don’t think this law will pass because change is automatically shunned, even change that won’t even affect 99.96% of us (only .04% will be affected).

    Interesting article, interesting comments.

    Mahalo!

    Aunty

  16. Aloha – meant to add in a side note. I would be opposed to this if it did affect those of us who are making moderate passive income from our retirement accounts (say it affected 20% of us). Our personal goal is $100,000 of passive income from our Roth Account would mean $8,333/mo of spendable cash flow. That is a sweet position to be in. So far, this proposed law will not affect that.

    Thus, for now, we will be building our Roth IRA in order to reach that point, and we may as well do that even in the looming shadow of a possible limit on contributions or account size.

    Mahalo,

    Aunty

  17. NateUVM says:

    @ Aunty – I think you are misinterpreting the article. The $205k is not in investment return (you’ve cited your $36k annual return). Rather it is the annual payout benefit that would result from placing the capped amount into an annuity. BIG difference!

    Also… Isn’t there already a cap on Roth IRA contributions…?

  18. NateUVM,

    Mahalo for pointing out that the $205K was about an annuity return. It is a big difference! Maybe that is good then, that we haven’t bought into an annuity plan?

    To tell the truth, we were considering it a few years back – annuity plans. However, the turn off was these young college kids with degrees that had houses (mansions actually) in Huntington Beach and super hot cars telling us about putting our funds into their company’s hands and guaranteeing us 6% annualized return forever.

    Maybe that would have been the case, since it was a good friend who introduced us to them and we got treated to a full course steak dinner at Morton’s Steak House, but somehow, I didn’t like the pitch or the product.

    Call me old fashioned but I like being in control of our funds and growing it in a non-fixed way with real estate or taking advantage of whatever is trending. I am not saying that I am better than those insurance companies that sell the annuity programs, I am just not inclined to listen to all hype propositions. I also don’t really believe anything is guaranteed, except taxes and death.

    You are also correct – there is a cap on Roth IRA contributions, but there is also a way to rollover funds from an IRA – which has less restrictions. I owe tax on that rollover, but also offset it with another contribution to a regular IRA. Joe Taxpayer has another blog site about Roth IRAs – i subscribe to his wisdom.


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