The Impact of a Retirement Savings Account Cap

[ERhoosier]

Highly compensated employees have been subject to limits on contributions for years.

But at least those individuals know they cannot contribute & can plan accordingly. Tying this to a floating total account value of a theoretical max annuity benefit would be an accounting nightmare for both taxpayer and the IRS.

joe & Texas- If you guys are investing in a world of 10% annual returns the value of annuity for max allowable defined benefit would be much lower (prob be 'only' ~$2M).

Anyway this is just a budget proposal. Entertaining to contemplate, but most doubt it has a real chance of passage. Although the political process can sometimes be unpredictable

 

[samclem]

Anyway this is just a budget proposal. Entertaining to contemplate, but most doubt it has a real chance of passage. Although the political process can sometimes be unpredictable

True, but it was floated for a reason. The way people react to it will determine how long it is before we see a more serious attempt of a similar type.

 

[Texas Proud]

But at least those individuals know they cannot contribute & can plan accordingly. Tying this to a floating total account value of a theoretical max annuity benefit would be an accounting nightmare for both taxpayer and the IRS.

joe & Texas- If you guys are investing in a world of 10% annual returns the value of annuity for max allowable defined benefit would be much lower (prob be 'only' ~$2M).

Anyway this is just a budget proposal. Entertaining to contemplate, but most doubt it has a real chance of passage. Although the political process can sometimes be unpredictable

Hey... I was just following joe...


I do believe that they would have to determine an actual dollar amount and not an annuity amount... to much fluctuation if it were defined as an annuity...

I also think they have to fix the age of the calc.... I did a quick check for me and DW... to get a joint annuity for both of us for $205K would cost us north of $4.8 mill...


I think when clearer heads look at the cost of implementing this tax to the benefit, it will (or should be) shot down...

 

[Htown Harry]

Yea! I can get to 3 million dollars! All I have to do is save $6000 annually at a compounded return of 10% for 40 years.

Had to check... but you are not quite there at 40 years... need a few months more to get there...

Now, compound at 12% and it is only 36 years...

These sorts of calculations, the revenue estimate in a post above and a sense of higher-end tax-deferred balances posted in previous threads suggest the proposed rules would affect very few people at ER.org.

We worker bees that build tax-deferred balances via the old-fashion method of contributions and compounding need to remember that there are many ways cumulative tax-deferred balances over $3M can accumulate: inherited IRAs, executives rolling over fancy deferred compensation arrangements into IRAs, etc.

On balance, I have no problem with the concept being proposed. Reducing "tax expenditures" should be fair game in the political give and take of federal budget discussions.

 

[seabourne]

A way to address the uncertainty of being able to contribute during the year to value at previous year's reporting. Would be pretty simple, and given that there is a total limit of ~$50k, proportionate to the $3.4M limit, allowing someone to contribute one extra year would do very little tax-reduction overall.

I agree that you'd have to use the annunity pricing now to set a reasonable baseline (and since rates aren't likely to get much less generous than these days....) and index that fixed dollar amount up. The fluxuation based on changing annunity pricing would be nuts and probably wouldn't gain much utility. The real value to government is having a moderate ceiling - it's the 10s of millions that are the issue, not the difference between 4.5 and 4.8 million that differing measures of inflation/increase would cause.

 

[samclem]

I think when clearer heads look at the cost of implementing this tax to the benefit, it will (or should be) shot down...

Well, the government doesn't pay the compliance costs, so much of the "cost" would be unimportant to some of the participants.

And it may be a step too far to assume the intent is to raise revenue at all. It could just be to increase fairness. That's a goal that gets discussed a lot.

 

[sheehs1]

I tend to think it is about redistribution of wealth and fast forwarding more immediate tax revenue to the government. Especially for those such as the CEO's with annual multi million dollar bonuses, hedge fund managers, etc. It may also hit the small business owners that may still have define benefit plans in place.

People that may be able to defer it today may not be able to in the future IF something like this passes. Clearly the result would be more tax revenue to the government. They in turn will redistribute it because it is what is done. I can see no other real or functional "intent".

Isn't it funny?. For decades our government wanted us all to save for retirement. Now they don't want us to save but so much. Now we have our government trying to tell us "what is enough".

I suppose I just don't like the premise of that. The truth of the matter is they will get tax money off of these accounts anyway. They just want to fast forward it.

At least that is how I see it. I can also acknowledge at some point, perhaps enough is enough. But who knows what another needs or why....

 

[scrinch]

IRA's were implemented as a way to encourage people who were not saving for retirement to do so, by giving them a tax incentive (deferral) on that savings. Contribution caps and MRD's were put in place to discourage people from trying to use these accounts to accumulate significant wealth without first paying income tax on it and pass that untaxed wealth on to heirs. Sounds to me like the limits being proposed now are just another way the government is trying to reinforce the original purpose of IRA's...to provide retirement income for those who otherwise might not have any. Sounds good to me...if you've got $3 million in your IRA, then you'll at least be able to minimally scrape by in retirement, and you can go ahead and pay taxes on this year's income this year. I agree they need to make the rule clear and easily followable (fixed dollar limits, not a floating annuity-equivalent amount) but have no problem with the principle.

 

[Chuckanut]

I don't like the idea especially if the following two things end up being true (I have no knowledge of this at this time)

1. The cap includes earnings. (The wording seems to indicate this.) Why should one be punished because he/she chose better investments than others? Or did not panic in a down market? Or picked the next Apple stock at the right time?

2. The cap is not adjusted for inflation. No inflation cap is a great way to raise taxes without having to vote to raise taxes. This is bigger than #1, IMHO.

If the goal is to get more money from the wealthy there are better ways to do that via closing tax loopholes and various subsidies. This idea strikes me as a way to ultimately stick it to the middle class as the years go by.

 

[Texas Proud]

Well, the government doesn't pay the compliance costs, so much of the "cost" would be unimportant to some of the participants.

And it may be a step too far to assume the intent is to raise revenue at all. It could just be to increase fairness. That's a goal that gets discussed a lot.

There will be forms that need to be created... there will be programs written to check and people to do audits, follow up on leads of people who do not comply etc. etc... the costs are not trivial to the IRS... I do not think that the investment community has a lot to do... there is no way any of them can know my total amount in tax advantaged accounts... they will just have to report the balance... and all that I know of already do that... now, the DB plans might not... I would not know as I do not have one.... but, an easy number to calculate....


I hate this 'fairness' BS.... a tax should not be imposed to make something look fair... especially if the expense of that tax costs more to collect than the amount of tax... how 'fair' is that

 

[Texas Proud]

I tend to think it is about redistribution of wealth and fast forwarding more immediate tax revenue to the government. Especially for those such as the CEO's with annual multi million dollar bonuses, hedge fund managers, etc. It may also hit the small business owners that may still have define benefit plans in place.

People that may be able to defer it today may not be able to in the future IF something like this passes. Clearly the result would be more tax revenue to the government. They in turn will redistribute it because it is what is done. I can see no other real or functional "intent".

Isn't it funny?. For decades our government wanted us all to save for retirement. Now they don't want us to save but so much. Now we have our government trying to tell us "what is enough".

I suppose I just don't like the premise of that. The truth of the matter is they will get tax money off of these accounts anyway. They just want to fast forward it.

At least that is how I see it. I can also acknowledge at some point, perhaps enough is enough. But who knows what another needs or why....

I remember way back when I did taxes.... we had a very successful attorney set up a DB plan... since he was already in his late 50s, he was putting away hundreds of thousands of dollars a year in the plan... his secretary loved it because he had to contribute for her.... but, I do not think there was a limit on how much he could put away except that he had to earn money to pay his salary....

 

[jollystomper]

I keep hoping for a simplified tax code, but proposals like these come along... I'm beginning to accept the fact the Cubs winning the World Series *and* the Browns winning the Super Bowl are more likely to happen.

 

[comicbookgujy]

At my current rate, if I continue to contribute 25% of my salary and have a 6% rate of return, I will have $7 millions when I turn 65.

Guess I 'll update my contribution rate from 25% to 6% to get just the matching rate so the government don't think i'm "WEALTHY."

 

[comicbookgujy]

The S&P rate of return from 1970 to 2010 was 10.05%(this doesn't even count the bull market for the past 3 1/2 years!!!!).

Saving $6k a year like the other poster say would make you "WEALLLLTHY."

Why does the government think saving is so hard?

By contributing 10.0% of your salary to your retirement plan you may accumulate a plan balance of $5,027,455 at retirement at an out-of-pocket cost of just $362,412. Accumulation analysis(%)($)Your contribution10%$6,000Employer match100%$1,800Maximum employer contribution3%$1,800Your cumulative contributions
$362,412Employer cumulative contributions
$108,724Total before-tax value in year 40
$5,027,455

 

[growing_older]

Devil will be in the details. It's hard (but not impossible) for a diligent saver to get into the $3 million territory in a tax deferred account. But a big saver who dies and wills their IRA to a child will certainly put that child into position to go over $3 million. Likewise, a saver who puts as much as possible into an account early in life, will have many more years for that account to reach and exceed $3 million without making additional contributions, but a late bloomer will find it much harder to reach the limit (barring the inherited IRA mentioned before).

It will certainly bring in a whole new set of tax diversification strategies. And if the $3 million is not indexed to inflation, or is subject to political uncertainty and revision, there could be all kinds of strategies that would affect savers or aspiring early retirees. If Roth and Traditional are both included in the cap, but count dollar for dollar the same toward the cap, then Roth accounts become even more valuable. It's hard to optimize around the rules, when the rules are unknown or changing all the time.

In some reports of the cap, it would be based on annuity rates at age 62, and indexed for inflation, but also affected by current interest rates. So if interest rates used to calculate annuities rise, the cap could fall. Without well defined details, and without any confirmation that this plan is anything more than a trial balloon, it's hard to have any definite idea how it would impact aspiring ERs.

 

[LitGal]

Fascinating and Informative Discussion.....

.... though (sadly) I must confess to drifting off a bit halfway through the thread, since a $3m cap will never be a concern for DH or me. (Most retired school teachers--especially those who worked many years part-time--probably don't amass such funds.)

However, there is much to be learned by reading the posts of the ER's who do. Thanks!

 

[bUU]

But at least those individuals know they cannot contribute & can plan accordingly.

This is not true. The IRS requires that testing be conducted annually to ensure that highly compensated employees are not benefiting substantially more than non-highly compensated employees. Plans that fail the tests must make remediation. Sure, they could might make additional contributions only for the lowest-paid employees (yes, that's not only legal, it is specified explicitly as one of the two remedies), but I suspect that it more likely that they'll take the other approach, "Distribution of the Excess", the plan returns the excess contributions to the highly compensated employees.

Ours is not a safe harbor plan. I don't have access to the data, of course, but I don't think our plan is far away from failing the ADP testing. For various reasons, I believe there is a significant probability that I will be told that I have to take an involuntary distribution, this year. But I don't know, and won't know until the end of the year, whether the contributions I've made this year will "stick".

Anyway this is just a budget proposal.

That's an important point: Saying that the proposal is bad because it doesn't have this provision or this specific detail outlined is silly - it just means that it needs to be amended or clarified. Big difference. I want to see the proposal have indexing to CPI specified, and I want its impact to be limited to limiting current-year contributions in any year after a year where your combined balances exceed the threshold. I think those would be nice amendments.

I did a quick check for me and DW... to get a joint annuity for both of us for $205K would cost us north of $4.8 mill...

The premise you outlined would be a reason to suggest that the number should be $4.8M instead of $3M or $3.2M. I'm not even sure about that, though, because you priced a joint annuity. The limit is expressed as an individual limit, and so it naturally would be expressed in terms of an individual annuity, regardless of whether or not that fit any one person's own personal preferences.

IRA's were implemented as a way to encourage people who were not saving for retirement to do so, by giving them a tax incentive (deferral) on that savings. Contribution caps and MRD's were put in place to discourage people from trying to use these accounts to accumulate significant wealth without first paying income tax on it and pass that untaxed wealth on to heirs. Sounds to me like the limits being proposed now are just another way the government is trying to reinforce the original purpose of IRA's...to provide retirement income for those who otherwise might not have any.

This is a very elegant way of expressing it.

Why should one be punished because he/she chose better investments than others?

I don't see anything about anyone being punished. The proposal is about limiting to whom tax advantage - an incentive - is offered. Not getting an incentive (for something you're clearly aim to do anyway) isn't punishment.

 

[sheehs1]

Devil will be in the details. But a big saver who dies and wills their IRA to a child will certainly put that child into position to go over $3 million.

+1
I was wondering about inherited IRA's and whether they would be included in the calculation. If so, and if anything like this passes, then I would think our IRA's might be the first thing we should spend rather than the last so as not to impact our children.

Hopefully, something like this bill will be DOA. There seem to always be unintended consequences that our legislators don't think thru IF they even read all the details (which I doubt!).

 

[MichaelB]

It's not a bill, it's a proposal, which puts it in the same category as a wish list.

 

[REWahoo]

It's not a bill, it's a proposal, which puts it in the same category as a wish list.

+1

Once it becomes law, then we'll get the bill...

 

[sheehs1]

It's not a bill, it's a proposal, which puts it in the same category as a wish list.

I suppose I was anticipating it being embedded in some bill.

 

[scrinch]

I hate this 'fairness' BS.... a tax should not be imposed to make something look fair...

I guess we see things differently, but to me closing a tax loophole for a certain segment of the population (high networth individuals) is a far cry from imposing a tax.

 

[sheehs1]

I remember way back when I did taxes.... we had a very successful attorney set up a DB plan... since he was already in his late 50s, he was putting away hundreds of thousands of dollars a year in the plan... his secretary loved it because he had to contribute for her.... but, I do not think there was a limit on how much he could put away except that he had to earn money to pay his salary....

Texas Proud, Years/decades ago, our family business had a defined benefit plan. After decades of our parents putting everything back into the business, it was the one way we could get them decent "retirement money". There wasn't any limit on what could be put in as I recall so you are correct.

After that, we implemented a 401 K instead. Not the same animal that is for sure.

 

[MichaelB]

I suppose I was anticipating it being embedded in some bill.

Could be, but IIRC that means it would have to come from the House Ways and Means committee, not the White House budget proposal.

 

[growing_older]

Most retired school teachers--especially those who worked many years part-time--probably don't amass such funds

Well, I guess part-timers probably do not amass much in the way of pensions, but the proposal does include the value of any defined benefit plan (such as a pension) in the limits. It's of course totally unclear how they figure the value or what happens if the cap is exceeded, or what happens if the combination of future pension and IRA savings exceeds the cap, or vesting, or many other specifics.