Five budget items that target retirement accounts

Five proposals were included in this year's federal budget that directly relate to retirement accounts. Here is a rundown of each proposal, its main benefit and its drawback. 1) Establish a “cap” on retirement savings, prohibiting additional contributions. The proposal — New contributions to tax-favored retirement accounts, such as IRAs and 401(k)s, would be prohibited once clients exceeded an established “cap.” This cap would be determined by calculating the lump-sum payment that would be required to produce a joint and 100% survivor annuity of $205,000 beginning when clients reached 62. Currently, this formula produces a cap of $3.4 million. Accounts could still grow as a result of earnings, and the cap would be increased for inflation. The benefit — Perhaps the only good news is that at $3.4 million, this provision would make an impact only on a very small percentage of retirement savers. But even here, if interest rates increased, then the cap could go much lower, since annuities paying $205,000 would cost less. This would affect many more retirees. The drawback — Many clients would require significantly more annual income in retirement to maintain their desired standards of living, especially after factoring in taxes. 2) Create a 28% maximum benefit for retirement account contributions. The proposal — The maximum tax reduction for making contributions to defined-contribution plans, such as IRAs and 401(k)s, would be limited to 28%. As a result, certain high-income taxpayers making contributions to retirement accounts would not receive a full tax deduction for amounts contributed or deferred. The benefit — For some clients, the good news is that unless they were in a federal income tax bracket higher than 28%, this provision would not increase their tax liabilities. The drawback — High-income clients no longer would be able to receive a true, full deduction for amounts contributed/deferred to a retirement account. 3) Eliminate RMDs for clients with $75,000 or less in retirement accounts. The proposal — Clients with combined savings, across all retirement accounts, of $75,000 or less would be exempt from required minimum distributions. The benefit — The proposal would decrease the compliance burden and increase simplicity for those individuals with smaller retirement account balances. The drawback — None. This provision would eliminate RMDs for nearly 50% of IRA owners. 4) Allow non-spouse beneficiaries to make 60-day rollovers of inherited funds. The proposal — Non-spouse beneficiaries would be allowed to move inherited retirement savings from one inherited retirement account to another via a 60-day rollover (in a manner similar to that in which they currently can move their own retirement savings). The benefit — Unifying the rollover rules for retirement account owners and beneficiaries would greatly simplify this aspect of retirement accounts and reduce the number of irrevocable and costly mistakes that are made by beneficiaries under the current rules. The drawback — No downside. Of course, if most beneficiaries would be required to empty the inherited account in five years (see the earlier proposal), this provision would be far less beneficial than it would be under current law. 5) Mandatory five-year rule for non-spouse beneficiaries. The proposal — Most beneficiaries of individual (and other) retirement accounts would be required to empty inherited retirement accounts by the end of the fifth year after the year of the IRA owner's death. This proposal is a potential game changer to many clients' estate plans. What makes this proposal scary is that it's not the first time it has been floated. The benefit — Requiring all non-spouse beneficiaries to withdraw inherited retirement account funds within five years would simplify the rules for both clients and advisers. The proposal would exempt certain beneficiaries, such as the disabled, and minor children. The drawback — This proposal would lead to the death of the stretch IRA for most non-spouse beneficiaries. They would face more-severe tax consequences upon inheriting retirement accounts, and, as such, the values of these accounts as potential estate-planning vehicles would be diminished. It also would significantly reduce the value of Roth conversions, particularly for older clients using them as an estate-planning strategy. Ed Slott (irahelp.com), a certified public accountant, created The IRA Leadership Program and Ed Slott's Elite IRA Adviser Group.