The Impact of a Retirement Savings Account Cap

[bUU]

You are kidding right?

No. The comment I was replying to said that the change would make planning "unpredictable". That is untrue. It changes the environment within which the planning takes place once, and then it returns to being just as predictable as it is now. Hopefully that makes it clearer.

Right now the process is real simple max out your 401K.

That's not true, but this isn't the right thread to discuss the reasons why you might not max out your 401k.

How much of your 2013 and 2014 salary to you contribute to your 401K and why?

I max out my 401(k) because I want to defer taxes as much as I am able. With this new system, I would watch my balance and if it got to $3M I would stop contributing.

By the way, my spouse's contract runs out in October, and we won't know until the last minute if she'll be renewed. So managing contributions to her 401k, maximizing her match, is an issue we deal with. It took about three minutes to determine the right approach, given the probabilities. If you need assistance with financial planning, be sure to take advantage of available resources, including online forums.

 

[george76]

If the government will be taxing the gains made by these accounts (when they exceed the magic number), I wonder if account holders will be allowed to write off losses from these same accounts when they decline in value?

I guess I don't follow. I thought the proposed rule was to keep allowing the gains within the account (tax-free if within a ROTH and tax-deferred if within a TIRA).

I haven't seen anywhere where the government will be taxing any gains within IRA's if they exceed a certain value. The only change would be that one no longer could add NEW contributions to the IRA if they exceed the magic number. Or am I misunderstanding what you are trying to say?

 

[Hamlet]

With the carried interest rules, I believe the issue is that Romney could put private equity that had already actually appreciated dramatically into the IRA with the much lower purchase price allowed by the carried interest rules.

Basically, there are loopholes in the system that allow private equity types and other highly compensated individuals to get around the contribution limits.

I'd be interested in closing those loopholes.

If someone happens to get lucky and ends up with a large balance without gaming the system, I don't think its really worth extra rules to limit their tax deferral.

The issue was to prevent what Romney did with putting stock that greatly appreciated into an IRA. So assume you some how knew that stock X was going to go up 500% you would not be affect by the limit although that was the reason the idea was proposed. It might be just that you must put your contributions into a publicly traded stock, etf, mutual fund, or bond fund, not a privately placed stock where this sort of gain is possible. Thus no making out like a bandit on tax deferred money.
Of course I would also change the rules so that inherited IRAs had to take RMD's based upon the creators age, (or in the case of the spouse of the creator, the age of the spouse, but no passing the thing down thru a chain of spouses). The idea here is that an IRA should terminate when the creator would have been 115 since its a retirement account, not a perpetuity.

 

[sheehs1]

Considering where the proposal came from. I would say the consequences as best as can be foreseen are considered desirable.

Ha

Perhaps but we really don't know what may be included or excluded to the proposal. Remember, we have the AMT tax that is hitting a lot of "folks" since it was not indexed for inflation. That was not the original intention or so they say.
We also have the SSN calculation that requires adding back in "tax free dividends and interest" that one does not have to include on the current 1040..

Taxes are on the rise. How our President and VP can pay that tax rate of 18% or 22% is beyond me. They must have a lot of debt for mortgage interest they can right off or proceeds from book sales that are not taxed at ordinary income rates or dividend income. A large part of their income was reportable and should have been taxed at ordinary income rates. So whatever "else" they have is significant to have brought their rate down so much.

Try as I might, my tax rate was still marginal at 33% and effective at 28%/29%. The only thing that would reduce it is student loan interest, a mortgage with a lot of mortgage interest, much larger charitable donations, start a business with businesses expenses, etc.

Seriously, things are just too darn complicated. I don't expect this proposal to be much different.

 

[kmt1972]

Perhaps but we really don't know what may be included or excluded to the proposal. Remember, we have the AMT tax that is hitting a lot of "folks" since it was not indexed for inflation. That was not the original intention or so they say.
We also have the SSN calculation that requires adding back in "tax free dividends and interest" that one does not have to include on the current 1040..

Taxes are on the rise. How our President and VP can pay that tax rate of 18% or 22% is beyond me. They must have a lot of debt for mortgage interest they can right off or proceeds from book sales that are not taxed at ordinary income rates or dividend income. A large part of their income was reportable and should have been taxed at ordinary income rates. So whatever "else" they have is significant to have brought their rate down so much.

Try as I might, my tax rate was still marginal at 33% and effective at 28%/29%. The only thing that would reduce it is student loan interest, a mortgage with a lot of mortgage interest, much larger charitable donations, etc.

Seriously, things are just too darn complicated. I don't expect this proposal to be much different.

Actually I spent time looking at Obama's tax returns. The reason his tax rates are so low is because he owns a small business (of selling his books) and because of that he is able to put 50K from his business income into an retirement account which is tax free. This had the affect of lowering his tax rate dramatically. There are other things but that is the main affect. Of course this is exactly the topic we are talking about, retirement account caps. If Obama did this every year for a couple of dozen years he would bit the $3 million cap as well.

 

[Hamlet]

They also gave 25% of their income away to charity. That has a huge effect on their effective tax rate.

Actually I spent time looking at Obama's tax returns. The reason his tax rates are so low is because he owns a small business (of selling his books) and because of that he is able to put 50K from his business income into an retirement account which is tax free. This had the affect of lowering his tax rate dramatically. There are other things but that is the main affect. Of course this is exactly the topic we are talking about, retirement account caps. If Obama did this every year for a couple of dozen years he would bit the $3 million cap as well.

 

[Texas Proud]

They also gave 25% of their income away to charity. That has a huge effect on their effective tax rate.

yep, hamlet got it in before I did...

 

[kmt1972]

They also gave 25% of their income away to charity. That has a huge effect on their effective tax rate.

Not really true. If you look at the return the Charity did not make that much of an impact since they in turn paid the AMT rate based on their AGI. I agree their charity got them below the AMT but the real issue is: Why is the AMT for the Obamas which is really 26 or 28 percent ended up only taxing them at 18 percent. The answer is what I talked about, they put 50K into retirement account tax free which lowered their AGI significantly so the AMT rate was applied to a much smaller number than their total income.

 

[kmt1972]

They also gave 25% of their income away to charity. That has a huge effect on their effective tax rate.

Actually I looked at it again. You are right, the charity also made a difference as that lowered the income where they were taxed on the AMT. Sorry for my earlier comments without looking at it closely enough. But the 50K tax free retirement account also made an impact as well.

 

[sheehs1]

I need to look at his returns because the AMT level is pretty doggone low when one considers a gross of over $600K.
Hard to think he could have brought his gross of over $600K down to below the AMT level.
I got hit with the AMT and I certainly did not have that type of gross. But neither did I have businesses expenses, that level of charitable donations or able to put away that much in a deferred IRA vehicle. (a large percent of my income is K1 income and not classified as earned).
And let's face it, he doesn't really need to "live" on his income at the moment. The rest of us do so we are careful about what we "give" away. Or at least I am.
Point being, not everyone who makes between $150,000 and $250,000 has those tax rates (18%-22%). Most of us are in the 28% to 33% brackets, particularly if you have few deductions and are basically debt free.

 

[MichaelB]

The tax return is here http://www.whitehouse.gov/sites/default/files/docs/complete_return_president_obama_2012.pdf

The key numbers

 

[samclem]

I thought the proposed rule was to keep allowing the gains within the account (tax-free if within a ROTH and tax-deferred if within a TIRA).

I haven't seen anywhere where the government will be taxing any gains within IRA's if they exceed a certain value. The only change would be that one no longer could add NEW contributions to the IRA if they exceed the magic number. Or am I misunderstanding what you are trying to say?

It appears to hinge onwhat the word "accrual" means in this context. As you can see from the comments here, there are many who believe the proposal is intended to provide immediate taxation of gains every year above a certain level.

 

[sheehs1]

Thanks MichaelB. Those are some pretty heavy duty exemptions with that mortgage interest of $45K, real estate taxes, retirement contribution, etc.

I am curious why the Obamas do not have to log their "personal use" of the airplanes that take them on (1) birthday forays to NYC (2) personal vacations to Hawaii and elsewhere (3) spring break trips for daughters (4) other personal use, on a W2 as income.

Understand why he would not have to do that for "business" use but the rest of us have to do it when it is strictly for "personal" use.

I suppose anything and everything is available for the President's family use for free/tax free.

 

[kmt1972]

Thanks MichaelB. Those are some pretty heavy duty exemptions with that mortgage interest of $45K, real estate taxes, retirement contribution, etc.

I am curious why the Obamas do not have to log their "personal use" of the airplanes that take them on (1) birthday forays to NYC (2) personal vacations to Hawaii and elsewhere (3) spring break trips for daughters (4) other personal use, on a W2 as income.

Understand why he would not have to do that for "business" use but the rest of us have to do it when it is strictly for "personal" use.

I suppose anything and everything is available for the President's family use for free/tax free.

Sorry if we are moving further off topic, but I found it interesting that Obama accrued losses of over $115K of which he gets to deduct a net $3K every year. I wonder which bad investment he made to get this kind of loss. I had a high income for a while and I lost money on investments plenty of times, but I do not thing I ever lost anywhere close to net $115K, even over a long period. Wow.

 

[MichaelB]

The $50K IRA contribution is on topic (not tax free but tax deferred). Why don't we stick to that and get back to retirement savings.

 

[george76]

It appears to hinge onwhat the word "accrual" means in this context. As you can see from the comments here, there are many who believe the proposal is intended to provide immediate taxation of gains every year above a certain level.

Yes, the word "accrual" is the issue. I think TexasProud in posting #75 explained it pretty well.

 

[haha]

Perhaps but we really don't know what may be included or excluded to the proposal. Remember, we have the AMT tax that is hitting a lot of "folks" since it was not indexed for inflation. That was not the original intention or so they say.
We also have the SSN calculation that requires adding back in "tax free dividends and interest" that one does not have to include on the current 1040..

Sorry, I think I was unclear. I mean that the administration that floated this idea wants as much as they can get, so negative consequences form the taxpayers POV may well be what was intended all along by the proposal. Like I have said before (as a broken record) we are screwed.

Ha

 

[samclem]

Yes, the word "accrual" is the issue. I think TexasProud in posting #75 explained it pretty well.

I don't think we know.

"If a taxpayer reached the maximum permitted accumulation, no further contributions or accruals would be permitted, but the taxpayer’s account balance could continue to grow with investment earnings and gains. "

This says nothing about whether the additional gains (over the "maximum permitted accumulation") will be taxed or not.

"Accrued interest" is a common term, but that use of "accrue" doesn't fit with the clause that follows it in the above quote.

The proposal is so sloppily worded as to, apparently, be a blank slate upon which people can project whatever meaning they prefer. We've seen that technique before . . .it doesn't lead to good outcomes.

 

[sheehs1]

Sorry, I think I was unclear. I mean that the administration that floated this idea wants as much as they can get, so negative consequences form the taxpayers POV may well be what was intended all along by the proposal. Like I have said before (as a broken record) we are screwed.

Ha

Got it. Now I understand what you meant!

 

[packrat44]

Very confusing.

The cap is set at the cost of an annuity that would deliver $205K (2013) to someone 62 years of age (adjusted up or down depending on age). Also stated defined benefit plans come into play in determining the cap. Since the President will receive a defined benefit of greater than the cap, does that mean he can not contribute to an IRA/457b and will have to remove whatever he has already contributed?

 

[clifp]

No. The comment I was replying to said that the change would make planning "unpredictable". That is untrue. It changes the environment within which the planning takes place once, and then it returns to being just as predictable as it is now. Hopefully that makes it clearer.

That's not true, but this isn't the right thread to discuss the reasons why you might not max out your 401k.

While there are rare occasions, when maxing out your 401K isn't the smartest thing to do, for 95% or so of the population, it is. The benefits of tax deferral while in higher tax bracket, tax deferred compounding, and generally a partial company match, outweigh the negatives of smaller number of investment choices, and often higher fees.

If we conducted a poll of the forum members and financial planners maxing out your 401K is going to be the top choice for smart retirement planning

I max out my 401(k) because I want to defer taxes as much as I am able. With this new system, I would watch my balance and if it got to $3M I would stop contributing.

By the way, my spouse's contract runs out in October, and we won't know until the last minute if she'll be renewed. So managing contributions to her 401k, maximizing her match, is an issue we deal with. It took about three minutes to determine the right approach, given the probabilities. If you need assistance with financial planning, be sure to take advantage of available resources, including online forums.

Why $3 million doesn't this approach mean you will miss out on the free money your company gives you for matching if you hit $3 million long before your retirement age? What if the price of annuities change and the cap increases to $4.5 million? I guess you miss out on all the benefits of tax deferred, company match, because you made your one time decision that once I see $3 million in my account I stop contributing.

Which is my point with the new system it requires you to pay constant attention to your retirement balances, this years cap, and factor in expected returns, company match etc. It is not a one time event. It is also not something that can be done in 3 minutes.

I agree with you about online forums, I wish they were available when I retired. But since I have actually been contributing to them for last 13 years or so. I am one of those resources. I'll spend 30 minutes or an hour reviewing people finances and give them my $.02 on what they should do many people have thank me for my advice.

However I guarantee if anything like the President's proposal comes to pass. This forum and other like we be filled with people asking the question, how much should I contribute to my 401K?. A simplistic answer like until you reach $3 million is wrong for 95% of the people with more than $1 million in IRA/401K, 403B etc. . My answer to their question will be I'll throw up my hands and say hell if I know.

The right answer requires a tool with several time the complexity of FIRECalc and then the best it can do is spit out probabilities. Retirement saving/planning is already too complicated for the vast majority of American the last thing we need is more complexity.

 

[Texas Proud]

While there are rare occasions, when maxing out your 401K isn't the smartest thing to do, for 95% or so of the population, it is. The benefits of tax deferral while in higher tax bracket, tax deferred compounding, and generally a partial company match, outweigh the negatives of smaller number of investment choices, and often higher fees.

If we conducted a poll of the forum members and financial planners maxing out your 401K is going to be the top choice for smart retirement planning

/snip/

Actually, I think you are wrong.... I would bet that a good majority of people should NOT max out their 401(k)... I make good money, but with deductions etc. am at the top of the 15% bracket or just into the 25%... it would be a bad choice for me to put away 15% money tax money... I would rather have the freedom of it being in a taxable account...

I also know a number of people who don't pay taxes at all... it is really stupid to put money aside if you do not save any taxes.... since they say 48% of people do not pay taxes.... that means there is no way 95% should max out....

 

[growing_older]

at the top of the 15% bracket or just into the 25%

This might put you into territory where a Roth 401k is better, depending on what you have saved in what kinds of accounts and what income you expect in retirement. Which is another complication to add to planning.

 

[clifp]

This might put you into territory where a Roth 401k is better, depending on what you have saved in what kinds of accounts and what income you expect in retirement. Which is another complication to add to planning.

Exactly. I was using 401K as short hand for taxed deferred investments, which includes Roths, and ROTH 401K Roths.

Texas is right for low wage earnings, you want to contribute as much to your 401K to receive the company match. Beyond that your tax bracket and other investment options matter. However, if you aren't paying taxes or are in the 15% tax bracket you aren't like to accumulate $1 to $2 million in tax deferred account where the restriction will hurt you. But for high wage earners taking maximum advantage of tax deferred is almost always smart. It worked well for me I have 1.4 million in my IRA by maxing out my 401K from 24 to age 40 and never contributing a dime after that.

 

[bUU]

Of course this is exactly the topic we are talking about, retirement account caps. If Obama did this every year for a couple of dozen years he would bit the $3 million cap as well.

Yes, he's clearly not making this decision for his own personal benefit.

And let's face it, he doesn't really need to "live" on his income at the moment.

Nancy Reagan was famously taken aback when a White House usher presented her first bill in 1981, saying, "Nobody ever told us the president and his wife are charged for every meal, as well as incidentals like dry cleaning, toothpaste, and other toiletries." They don't have to pay rent or for the electric, though.

The cap is set at the cost of an annuity that would deliver $205K (2013) to someone 62 years of age (adjusted up or down depending on age). Also stated defined benefit plans come into play in determining the cap. Since the President will receive a defined benefit of greater than the cap, does that mean he can not contribute to an IRA/457b and will have to remove whatever he has already contributed?

Again, I suspect that the "have to remove" stuff isn't real... that the rules once written would simply cut-off further contributions. Regardless, yes, I'm sure that it would apply to the President just like it would apply to anyone else.

While there are rare occasions, when maxing out your 401K isn't the smartest thing to do, for 95% or so of the population, it is.

Yet, with the new rule in place, it is still completely predictable, which is the issue that I was replying to, there.

The benefits of tax deferral while in higher tax bracket, tax deferred compounding, and generally a partial company match, outweigh the negatives of smaller number of investment choices, and often higher fees.

As I said this isn't the right thread to discuss the reasons why you might not max out your 401k. It is worthy to note that, especially for employees of small businesses, 401k match is an endangered species. (I don't get any, and my spouse won't get any because it is a one year contract and the company has two-year vesting for matching - how nice.) We also get really crappy fund choices: I have only one fund with an ER under 1.3%, and that's a S&P 500 Index fund at 0.86% (which most S&P 500 Index funds are around 0.2%).

Why $3 million doesn't this approach mean you will miss out on the free money your company gives you for matching if you hit $3 million long before your retirement age?

The way it reads to me: yes. Definitely.

What if the price of annuities change and the cap increases to $4.5 million? I guess you miss out on all the benefits of tax deferred, company match, because you made your one time decision that once I see $3 million in my account I stop contributing.

Incorrect. You simply restart contributions when you're allowed to. If your company offers you company match, you can take advantage of that. You lucky dog.

Which is my point with the new system it requires you to pay constant attention to your retirement balances, this years cap, and factor in expected returns, company match etc.

You mean it requires careful planning for retirement? How is that any different from today? Answer: It isn't. As someone who's trying to power though yet-even-more complex decisions right now, I can say that I'm not even slightly concerned about what would extra work this new cap would add in: It would be trivial as compared to what people already need to work through.

It is not a one time event. It is also not something that can be done in 3 minutes.

Fair enough: 3 minutes a year. Try figuring out how much you're going to use of your HSA each year in such a short period of time. Or which year you're going to take capital gains from a holding you're planning to sell. And so on... Those are regular events for people who have that much money, that they have to do continually, if they're being conscientious about their financial future.

However I guarantee if anything like the President's proposal comes to pass. This forum and other like we be filled with people asking the question, how much should I contribute to my 401K?

And this forum is a ghost town now? No one has any questions? <shrug>