What Obama’s Budget Proposals Could Mean For Your Retirement
March 12, 2014Earlier this month, a colleague of mine forwarded me this article by Jeffrey Levine. In the article, he outlines some of the changes President Obama is proposing in his 2015 budget. While it is unlikely that these provisions will be enacted anytime soon, it does raise the specter of possible changes in the future so it’s important to understand the short and long term ramifications for you and your retirement plans if they ever do come to pass. Here are some things to consider, along with my take on each proposed provision:
Required minimum distributions for Roth IRAs (UNFAVORABLE)
It’s true that traditional IRAs and traditional and Roth 401(k)s are subject to required minimum distributions (RMDs), so it would make sense to apply the same rules to the Roth IRA. I see two potential benefits for the government to do this. One, it may keep tax-free accounts from growing larger and ultimately being passed on to beneficiaries. Two, it increases the likelihood that an RMD will be missed, which currently results in a 50% penalty tax on the difference between what was required to be distributed and what actually was distributed (i.e., the deficiency).
If this provision passes, the immediate impact could be an increase in deficiencies resulting from confusion over the application of this provision. If you or someone you know has a Roth IRA and is age 65 or older, pay attention to what is being said about this issue. The long-term impact will likely be a reduction in the amount of tax-free assets that transfer to the next generation. Taxpayers that are planning to do this may end up simply taking their tax-free required distributions and gifting them to the next generation, which may accomplish the same end goal, if only to a lesser extent.
Putting a limit on the benefits of contributing to a retirement account (UNFAVORABLE)
A provision like this may make you wonder if the government is even paying attention. Just about everywhere you look, including our own research, suggests that there is a large gap between how much employees are saving and how much they will likely need to save for a comfortable retirement. Such a provision would be a disincentive to participate in retirement plans like a 401(k) and make the current retirement gap even larger. A provision like this would most likely effect only high-income earners and they would probably adjust by contributing to nonretirement accounts as an alternative.
No more “stretch IRA” (UNFAVORABLE)
Unlike the previous proposal, which would mostly impact high-income earners, this proposed provision would have a much greater reach. Currently, non-spouse beneficiaries may elect to receive distributions from an inherited traditional retirement account within five years of death or over their life expectancy—sometimes referred to as “stretching” the account. By stretching the distributions, young beneficiaries prolong the benefits of tax-deferred growth. However, taking away this option could force beneficiaries to take large taxable distributions that may push them into higher tax brackets, essentially eliminating the benefits of tax-deferred savings. Janet Novack, staff writer for Forbes, offers these 4 steps in preparation for the elimination of the stretch IRA.
Putting a “cap” on contributions to a retirement account (UNFAVORABLE)
As discussed earlier, this would affect mostly high-income earners but the impact could trickle down, as unintended consequences may lie in the details. I’ve personally worked with young employees that are projecting nest eggs that would easily eclipse the levels described in the proposal based on current interest rates. The immediate impact would probably be minimal but employees that still have a long time to save will need to continue to save diligently, even if such a provision were to be put in place.
Eliminating RMDs for smaller balances (IN FAVOR)
Well, at least this provision makes sense. By NOT requiring distributions there is a better chance of preserving an inheritance for beneficiaries—although at this point, the $100,000 threshold doesn’t seem like much but it’s a start. As far as I can tell, the immediate impact would be positive as would the long-term impact, so this one I’d be in favor of.
Allowing non-spouse beneficiaries to take advantage of the 60-day rollover option (IN FAVOR)
This would apply to people of all income levels and should simplify things. I don’t see any real downside to implementing this provision. The short term and long term implications would be the same: fewer people getting hit with unnecessary taxes because of confusion applying the current rules.
Requiring small business owners to auto-enroll employees (NEUTRAL)
Any provision that will help employees to save more for retirement is a good thing but this should be done on a voluntary basis. By making this a requirement, employers may think they’ve satisfied their fiduciary responsibility to their employees by simply complying with the law rather than making an effort to provide all the necessary tools and resources to enable their employees to achieve a comfortable retirement. By the same token, employees that are automatically enrolled may also feel as though they have no further need to plan for retirement. Since most information out there on the subject suggests that employees are not saving enough, neither situation is acceptable. Employers and employees alike will need to take extra measures to prepare for a retirement that will likely require more savings by employees because of rising medical costs, lower projected Social Security benefits, and increasing life expectancy.
It’s good that the federal government is concerned about the state of retirement preparedness but changes in the laws alone won’t likely encourage the behavioral change necessary to get employees where they need to be. It will take the combined efforts of Washington, industry experts, employers and employees alike to build a system that is fair and reasonable. This is likely the first step ahead of many to come so be ready.