$3.4 million provides $210,000 annual retirement income?

[Shawn]

Yes, but how can it possible be effective or worthwhile for the uber rich if they are in the highest tax bracket when deferring and when withdrawing? Why bother?

I don't see how a Bill Gates or even Mitt Romney get any juice from these if they defer a the maximum rate and then withdraw at the maximum rate.

Even if the tax deferral rate going in is the same as the tax payment rate coming out, it's still better to defer. The difference is that the person who defers doesn't have to pay capital gains taxes (or taxes on annual dividends) on the earnings. The person who defers eventually pays income taxes on the original investment plus the investment returns. The person who does not defer initially pays income taxes on the original investment and eventually pays capital gains taxes on the investment returns. But here is the tricky part. Because the investment is initially taxed at the income tax rate, the person who does not defer is effectively paying regular income taxes on the investment returns too. In essence, the investment returns are pre-taxed at the income tax rate.

Consider the following example. For simplicity, assume a 50% income tax rate, a 25% capital gains tax rate, a 10% return rate (no dividends), and a 30 year investment period. Assume Bill Gates and Mitt Romney both have $10K available to invest. Bill puts his money in a 401K. Mitt puts his money in an after-tax account.

After 30 years, Bill's $10K grows to about $174K inside his retirement account ($10K x 1.1^30). He withdraws the money from his account and pays 50% in taxes. He now has $87K to spend.

Mitt can invest only $5K because his $10K is initially taxed at 50%. After 30 years, Mitt's $5K grows to about $87K - the same as Bill's. Mitt withdraws the money from his taxable account and pays 25% in capital gains taxes on the earnings. He now has only $67K to spend. This is about 25% less than Bill.

In this example, the benefit of deferral is basically equal to the capital gains tax rate. So deferral is very advantageous even when the before and after tax rates are the same.

Admittedly, Bill and Mitt probably don't care because the amount they can contribute to a 401K is trivial compared to their overall portfolio's. But it matters to me. Even though I'm not Bill Gates or Mitt Romney, I have a sizable DB pension waiting for me and my marginal tax rate in retirement will be (almost) the same as the rate while working. Deferral is good.

 

[samclem]

Perhaps it is, but so what?

My big concerns are:
1) the complexity and reporting requirements that would be levied on millions of people who would wind up paying nothing. This is an asset test, and includes DB plans and all manner of other things with values that go up and down depending on interest rates, age, etc. I don't have to figure any of that stuff out now, but after this, I would. Isn't compliance onerous enough?
2) How will the limit change in the future?

 

[pb4uski]

The article that I read didn't mention DB plans at all, just 401k and IRAs, so your first concern seems unfounded. Taxpayers might have to determine whether their far-flung 401k and IRA accounts meet the limit, but that could be a good thing in that they would be required to look at their balances at least once a year at tax time and it might encourage them to simplify the number of accounts they have.

On the second, many limits in the code (401k contributions, IRA contributions, HSA contributions, tax brackets, etc.) increase with inflation so that would be the most likely result.

 

[samclem]

The article that I read didn't mention DB plans at all, just 401k and IRAs, so your first concern seems unfounded.

Probably not. This source says it is all retirement accounts, to include DB, IRA, 401K, etc. Which mirrors the administration's proposal from 2013.

The amount brought in now would be relatively minor, but escalating later (and as interest rates rise)

According to modeling done by the Employee Benefit Research Institute, more than one in 10 current 401(k) participants are likely to hit that cap before age 65 and even more will when interest rates begin to rise.

If it's 10% of the public, it's probably 50% of the forum members here.

Taxpayers might have to determine whether their far-flung 401k and IRA accounts meet the limit, but that could be a good thing in that they would be required to look at their balances at least once a year at tax time and it might encourage them to simplify the number of accounts they have.

Not a goal of our tax code. I'm satisfied to let people decide for themselves whether this exercise is worth their time. Or, we could require people to track and enter their blood pressure and height/weight, too, under the premise that it would do them good to think about these things.

 

[daylatedollarshort]

If it's 10% of the public, it's probably 50% of the forum members here.

It is a per person limit, not per household, and only retirement accounts, not total net worth, so based on previous net worth polls here I suspect way less than half on this forum would be impacted.

 

[samclem]

Right now the IRS doesn't collect any information about the balance of any of our accounts. This proposal changes that and provides a new "in" to allow taxation based on assets rather than income. Some people think that is great. I don't.

The history of our tax code makes it clear that this new way to discriminate (based on wealth and not income) and to differentially tax using this method will not remain restricted to "the rich". Of course, maybe it will be different this time. . .

 

[harley]

I don't see how a Bill Gates or even Mitt Romney get any juice from these if they defer a the maximum rate and then withdraw at the maximum rate.

Don't forget, these are people who will never need to withdraw from these accounts. And Roths are passed on to heirs outside the taxable estate, with no RMDs and no taxes. They can be rolled into the heir's Roths, then passed on to the next generation. With good planning, no changes in the tax laws (unlikely), and responsible heirs (even less likely), a family could build up a huge untaxable empire and rule the world!

Personally, I see this as a sweet little loophole, and wish I had the juice to make better use of it.

 

[mpeirce]

On the second, many limits in the code (401k contributions, IRA contributions, HSA contributions, tax brackets, etc.) increase with inflation so that would be the most likely result.

Call me a cynic, but I'd bet that they'd "neglect" to index it.

Then we'd get into the situation that over time it starts hitting more and more folks, but since it's taking in so much more money, they can't afford to fix it.

Just like the AMT.

 

[Empresario]

In my final analysis, encouragement of personal responsibility will ultimately help eliminate personal dependency. Thus, I am not a proponent of discouraging savings or wealth preservation.


Sent from my iPhone using Early Retirement Forum (that's why it's brief!)

 

[Big_Hitter]

Not at all. All it does is say that once you have a lot, there are limits on the benefits of tax deferral. It doesn't matter if you have been slow and steady, or a really good stock picker, or whatever.

Also remember, that is for one person, so for a married couple the limit would be $6.8 million. And the limits will probably be indexed to inflation.

when they tried to do this two years ago the accounts are converted to an annuity at 62 and compared to the 415 limit; thus, someone with a relatively "large" DC balance that's in his or her 40s could be affected - i.e. prohibited from deferring monies

 

[Big_Hitter]

The article that I read didn't mention DB plans at all, just 401k and IRAs, so your first concern seems unfounded.

this included DB two years ago (regardless of what the article says), effectively repealing the combined 415 limits

 

[Big_Hitter]

here is a more technical write up of how this would work


The Impact of a Retirement Savings Account Cap | EBRI

 

[Independent]

Simulation results for 401(k) participants assuming no defined benefit accruals and no job turnover show that more than 1 in 10 current 401(k) participants are likely to hit the proposed cap sometime prior to age 65,

A common theme on this board is that "most Americans don't save nearly enough".

The EBRI says that 10% of us are saving at rates that will provide a non-COLA'd income of $210,000 at age 62. That might be a COLA'd income of $105,000.

Now, the median annual earnings of US full-time, year-round workers are somewhat above $40,000. If 10% are saving at those rates above, there must be lots more people who are saving enough to maintain a $40k lifestyle in retirement.

 

[Independent]

My big concerns are:
1) the complexity and reporting requirements that would be levied on millions of people who would wind up paying nothing. This is an asset test, and includes DB plans and all manner of other things with values that go up and down depending on interest rates, age, etc. I don't have to figure any of that stuff out now, but after this, I would. Isn't compliance onerous enough?
2) How will the limit change in the future?

You seem think we have "millions of people" who are close to $3.4 million in retirement savings, but don't already sit down once a year and add up the assets in their accounts.

I don't. I think that very few people have that kind of money, and those that do already know their balances closely enough to determine where they stand relative to $3.4 million.

I understand that this would require employers to give their workers a once per year PV of their DB plans. I think the gov't should require that anyway, with or without this limit.

 

[samclem]

You seem think we have "millions of people" who are close to $3.4 million in retirement savings, but don't already sit down once a year and add up the assets in their accounts.

What I think: Right now I don't have to take the time and trouble to enter in the balances for all my retirement accounts for the annual IRS data probe. Neither do any of the hundreds of millions of people who file tax returns and have a retirement account. If this idea passes, all these people will have to take the time to do that. It doesn't matter if a person is "close to $3.4 million" or not--everyone will need to supply the data (or how will the IRS know if a person is "close" or not?).
We have an >income< tax, so I can see that I have to provide information on my >income<. Beyond that . . . nope. It just gives another means for mischief-makers to make mischief.

 

[robnplunder]

If anyone has more than $3.4M, I am guessing the person is already far better off than having to worry about the proposed 401k limit. He'd certainly have other assets and would have trouble spending down the 401k before he die. I am probably the only one on this but I think the limit should even go lower. 401k's intent is to complement SS which isn't enough for most. It shouldn't be used to accumulate wealth.

 

[Big_Hitter]

If anyone has more than $3.4M, I am guessing the person is already far better off than having to worry about the proposed 401k limit. He'd certainly have other assets and would have trouble spending down the 401k before he die. I am probably the only one on this but I think the limit should even go lower. 401k's intent is to complement SS which isn't enough for most. It shouldn't be used to accumulate wealth.

look at figure 2 from the pdf in post 37 - it's far less than 3.4M depending on age

 

[Independent]

What I think: Right now I don't have to take the time and trouble to enter in the balances for all my retirement accounts for the annual IRS data probe. Neither do any of the hundreds of millions of people who file tax returns and have a retirement account. If this idea passes, all these people will have to take the time to do that. It doesn't matter if a person is "close to $3.4 million" or not--everyone will need to supply the data (or how will the IRS know if a person is "close" or not?).
We have an >income< tax, so I can see that I have to provide information on my >income<. Beyond that . . . nope. It just gives another means for mischief-makers to make mischief.

Okay, I see the difference. I'm assuming that I would not have to prove to the IRS that I'm under the limit.

Just like I don't have to prove to them that I didn't withdraw money from my IRA this year, or that the kids I listed as dependents really do meet each and every test for "dependent".

At most, I could imagine a checkbox (like foreign assets) where I can check "No".

 

[Independent]

If anyone has more than $3.4M, I am guessing the person is already far better off than having to worry about the proposed 401k limit. He'd certainly have other assets and would have trouble spending down the 401k before he die. I am probably the only one on this but I think the limit should even go lower. 401k's intent is to complement SS which isn't enough for most. It shouldn't be used to accumulate wealth.

You're not the only one, because I'd vote with you.

 

[marko]

I've said it on this forum a dozen times: These plans for 'curbing the rich' all make great headlines but miss the fundamental point: the rich just have too many options available to them.

It's financial whack-a-mole. Cut them off in one area and they'll just find another strategy. Even when you think the super rich lose, they win.

 

[2017ish]

If anyone has more than $3.4M, I am guessing the person is already far better off than having to worry about the proposed 401k limit. He'd certainly have other assets and would have trouble spending down the 401k before he die. I am probably the only one on this but I think the limit should even go lower. 401k's intent is to complement SS which isn't enough for most. It shouldn't be used to accumulate wealth.

Ummm. No. At least not for DW. She isn't working until 62, so may not have quite that much, but the vast majority of her (and our) assets are in retirement plans. As for difficulty in drawing down before death, our concerns are quite the opposite....

In any event, we aren't losing any sleep over this. Given the odds of it passing, I see the question as being akin to analyzing how many angels can fit on the head of a pin.

 

[pb4uski]

A few thoughts. In concept, I can agree with the notion of limiting tax deferral after on has accumulated a certain amount. However, they are making it way to complicated as they have a tendency to do.

First, forget about including DB plans. There are fewer and fewer DB plans out their every year (especially contributory DB plans) so their inclusion will become less and less meaningful over time and there are measurement difficulties with DB plans and it doesn't have much of a connection with their stated goal, so forget them.

Second, make it simple. If at the end of the year your 401k, 403b, 457, IRAs, etc. (in other all tax deferred accounts excluding DB plans) exceed $3.4 million then you can no longer contribute. Any contributions between the prior year end and the filing date of the return can be withdrawn with no penalty, but become taxable income in the year withdrawn. If the balance slides back under the cap at the end of any subsequent year then you can resume contributing. If the balance grows faster than the growth of the cap then you will not be able to make future contributions. Make the cap increase with inflation like the tax brackets do.

Third, compliance is self regulated like many things in taxes an is subject to audit. However, if you violate the rule beyond the filing date of the return (including extensions) then make the penalties onerous (similar to the penalties for excess IRA contributions).

 

[clifp]

If anyone has more than $3.4M, I am guessing the person is already far better off than having to worry about the proposed 401k limit. He'd certainly have other assets and would have trouble spending down the 401k before he die. I am probably the only one on this but I think the limit should even go lower. 401k's intent is to complement SS which isn't enough for most. It shouldn't be used to accumulate wealth.

At the 6% or 8% discount level I'd have already hit the cap. If I had continued working I'd be very close to 4% cap. Why should I be penalized on my employers 401K matching fund, or a pension benefit just because I was good saver and investor.

200K is a lot money to spend by most board members standards, but not necessarily in high cost of living place like the SF Bay Area, or NYC, or Honolulu. I suspect many of us know families making 300,400,500K and spending most all of it, who's sole saving are in 401Ks, or pension plans.

As Table 2 in the PDF shows the amount of money at a given age you can save is highly dependent on the discount rate. In a more normal interest rate environment this rate would fluctuate with the business cycle, thus causing people to have to cut saving during boom times,and allow them to save more recession. Which of course is completely the opposite of what we want high earner to do during a business cycle.

 

[enginerd]

10 years from now, I plan to have more than $3.4 in my retirement accounts. I assume that would mean withdrawing all gains every year and pay full income tax?
I would be younger than 59.5, would i also have to pay a 10% penalty on top of that too?

This would really make me have to re-think my strategy. It would probably add a couple years to my current plan.

 

[Big_Hitter]

^ you would pay ordinary income and fica/medicare I believe, which you already paid on your deferrals...D'OH...pretty sure there would be no 10% penalty