For the past few years President Barack Obama's fiscal year budgets have included a variety of proposed changes to the retirement system in the United States. Both the 2016 and 2017 proposed fiscal budgets included a $3.4 million cap on retirement savings for an individual. The cap would be imposed on the aggregate of an individual's retirement accounts, 401(k)s and IRAs.
Really, this proposal would represent minimal tax savings impact for the federal government, and is primarily designed to target wealthier Americans. In fact, the budget proposal even states that the cap would still allow Americans to save for a “reasonable level of consumption in retirement,” implying that savings in excess of $3.4 million might perhaps be considered unreasonable. However, critics of the proposal claim that it impacts very few people, and could, by its very existence, create the impression that the government is putting a damper on retirement savings.
How many people would this proposed change actually impact? According to a 2014 report published by the Government Accountability Office concerning IRA account holders, there are almost 9,000 Americans who have accumulated more than $5 million in an IRA. However, the proposed cap would be a soft cap, allowing more than $3.4 million in an IRA or 401(k), as long as the amounts that exceed the cap are earnings, not contributions. Another interesting finding in the Government Accountability Office report was the estimate that there are 1,000 Americans with more than $10 million dollars saved in an IRA. While there are questions about the accuracy of the GAO's estimates, we know that these mega million dollar IRAs do exist among the very, very rich. Mitt Romney, for example, reported having an IRA worth between $20 million to $102 million.
The next question is how would the proposed cap actually impact these gargantuan accounts? Well, with contribution limits today at $5,500 per year for an IRA, accumulating a huge amount of money inside of an IRA seems impossible at first glance. Additionally, back in 2002, contribution limits for traditional IRAs were only $3,000 a year, not including the age 50 catch-up contribution. However, SEP IRAs, 401(k) plans and defined benefit plans can be used to accumulate a much more substantial amount of money because the annual contribution limits are far greater. An individual can contribute between $53,000 and $59,000 annually in a 401(k) depending on the type of plan and the age of the individual. Additionally, if an employee maxes out a defined benefit plan, it could be worth north of $3 million.
In fact, the $3.4 million cap was established by calculating the lump-sum amount that would be needed to secure a 100% joint and survivor annuity of $210,000 per year starting at age 62, which is the maximum benefit one can accrue at age 62 in a defined benefit plan today. So, while someone is unlikely to contribute enough money to an IRA to ever reach the cap, an individual could reach the cap in a 401(k) plan or defined benefit plan.
However, even in most 401(k) plans or defined benefit plans, it is unlikely that an individual would have more than $3.4 million dollars of contributions, even for someone with more than $10 million in an IRA. Really, to reach $10 to $100 million in qualified plan assets you would most likely need some employer stock in the 401(k) plan and have that stock experience tremendous growth. A balanced investment approach is unlikely to get you there. In that situation, it is more likely that most of the money is a result of growth and investment earnings. So even for individuals with multi-million dollar IRAs and 401(k) balances, the proposed cap would simply limit their ability to contribute more money to an IRA or 401(k), but would do little at that point to limit their ability to receive the tax-deferred growth benefits offered in the retirement account.
Jamie Hopkins is a professor of tax at the American College's Retirement Income Certified -Professional program. Follow him on Twitter @jamiehopkins521.