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

One 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 [3], 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course, there are issues surrounding the fact that, eventually, taxes would have been collected on the money if it were withdrawn from a tax-deferred account down the road.)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 [4], 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 [5]. 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 [6]