Obama’s Budget Would Cap Tax-Advantaged Savings

New IRA limits target the wealthy. But this may be just the start of a raid on America's nest eggs.

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JIM WATSON / AFP / GETTY IMAGES

President Barack Obama speaks during a press conference in the East Room of the White House in Washington, Nov. 14, 2012.

Some of us have worried for decades that when America’s tax-advantaged savings pot got large enough, our perpetually revenue-challenged federal government would raid the nest egg. All that untaxed growth would simply prove irresistible.

That day may be at hand. President Obama’s budget, just sent to Congress, proposes to cap tax-advantaged savings across all accounts at $3 million in order to raise $9 billion over 10 years.

The proposal is being spun as a way to prevent wealthy private-equity executives from amassing huge IRAs—like Mitt Romney’s, once estimated to be worth as much as $100 million. But it would also curb the savings ability of self-employed professionals like doctors and lawyers. As these business owners reach the cap, and there’s nothing left in it for them, they might shut down or reduce plans that benefit their employees.

(MORE: Young Workers with a 401(k) Finally Get Diversified)

The cap proposal is a clear play to unlock some of the $10 trillion sitting in IRA and 401(k) accounts, which have become the primary retirement savings vehicles in America. Congress pried this door open a few months ago by toying with a law forcing heirs to liquidate an IRA within five years—almost certainly triggering otherwise avoidable income-tax payments. We may see that yet.

Now the president is wedging the door open further with a proposal that targets the wealthy. This is how it starts. What’s next? Taxing the growth in Roth IRAs?

Social Security benefits were once sacred and unencumbered. That began to change about 30 years ago; today roughly 85% of Social Security recipients pay some kind of income tax. The attack has not let up. The president’s new budget seeks to cut future Social Security benefit increases by tweaking the inflation formula.

Now lawmakers are moving on to the next bucket of cash. It’s not clear how the IRA cap would be enforced. Would savings beyond $3 million be disallowed? Or taxed right away? If you already have more than $3 million in IRA and 401(k) accounts, might you be forced to take immediate taxable distributions? Would Roth IRAs and traditional pensions be included under the cap? Hopefully, the budget will provide some answers.

The $3 million cutoff is itself something of a mystery. The White House reasons that $3 million is enough to provide an annual annuity of $205,000, which it further reasons is plenty income for any retiree. Yet there’s a lot wrong with this line of thinking.

Start with the mathematical assumption that $3 million can reliably generate $205,000 of annual income for a couple for 30 years or more of retirement. This calculation assumes a Herculean low-risk annual return of 7% at a time when Treasury bonds yield less than 2%. Don’t try this at home.

(MORE: Savings Booster: Making it Simpler to Repay Your 401(k) Loan)

Insurers will underwrite additional risk to give you a higher guaranteed rate of return. But they won’t go as far as the president would like to you believe. According to immediateannuities.com, a 65-year-old couple with $3 million can purchase an immediate, single-premium annuity that will pay $170,316 a year until the second one dies. This is taxable income, by the way. Is $110,000 or so a year, after all taxes are paid, really plenty income at a time in life when health costs can be astronomical? It’s not bad. Don’t get me wrong. But it’s not rich.

Let’s not shed too many tears for the wealthy professionals who can amass $3 million in an IRA. They’ll be fine. The thing to worry about is the kind of slow creep that continues to degrade Social Security benefits. Is the door to our tax-favored nest eggs one we really want to open?

13 comments
MiddleClass
MiddleClass

A middle class family such as mine that has been depositing 10-15% of their salaries into 401K's for the 20 years and will retire in another 20 years will need approximately $6-8M to maintain the same lifestyle through until death.  I have saved responsibly and have a realistic chance to get there only now to find out that the government is changing the rules?!?  Here we go again, reward the lazy and make those who worked hard, acted responsibly, and saved pay up.  

Simply put, my neighbors who make more than me but double mortgage their homes and drive expensive cars but save nothing will be receiving the money that I've been saving for all these years.  We are reaching dire straits at this point.  Something has to change!

jafo232
jafo232

This is a great idea, said nobody with a brain ever..

Phil_in_AZ
Phil_in_AZ

Socialism at its worst. I am 47 and have put the max into my 401k for 25 years, and have had pretty much your standard employer match. Over 25 years I have pretax contributions of about 450,000. I have made some smart investing decisions and now have $1.2 million. I won't retire for another 12 years at least. It's easily possible that my account could top 3 million. Someone please tell me why I am the bad guy?

CrossWinds
CrossWinds

Concerned about American middle class Jobs????  but no word on Keystone Pipeline............

adamnash
adamnash

@gregbettinelli For large Roth IRAs, you make private equity transactions in an IRA. Think $FB stock & Peter Thiel.

adamnash
adamnash

@gregbettinelli It's not that complicated. If you buy FB stock in the series A with your Roth IRA, you get there.

MiddleClass
MiddleClass

@Phil_in_AZ 

The baffling thing is that 3 million dollars is only going to provide you with a solid middle class retirement at your retirement age.  Somehow we're mixing middle class up with rich!!  

LoganDobson
LoganDobson

@JoshDStewart I mean, I don't have that now, but I do hope to have a pretty large amount in there by the time I retire.

JoshDStewart
JoshDStewart

@LoganDobson Yeah, me too. But this proposal just means that only $3 million in IRA money is tax free, right? 401ks are still exempt.

JoshDStewart
JoshDStewart

@LoganDobson Maybe they should add a loophole within the policy to get rid of the loophole... "the reasonable transfer exemption".