There is a familiar proposal in President Obama’s Fiscal 2017 Budget that seems to crop up every year—aimed at placing a cap on amounts that can be accumulated in tax-deferred retirement savings plans.
According to an Internal Revenue Service document explaining the proposals in the budget, Obama believes the current limitations on retirement contributions and benefits for each plan in which a taxpayer may participate do not adequately limit the extent to which a taxpayer can accumulate amounts in a tax-favored arrangement through the use of multiple plans—especially defined benefit plans, defined contribution plans and individual retirement accounts (IRAs).
“Such accumulations can be considerably in excess of amounts needed to fund reasonable levels of consumption in retirement and are well beyond the level of accumulation that justifies tax-advantaged treatment of retirement savings accounts,” the document says.
Obama contends that requiring a taxpayer who, in the aggregate, has accumulated very large amounts within the tax-favored retirement system to discontinue adding to those accumulations would reduce the federal deficit, make the income tax system more progressive, and distribute the cost of government more fairly among taxpayers of various income levels—while still providing substantial tax incentives for reasonable levels of retirement saving.
Obama is proposing to cap the accumulation into retirement accounts at $3.4 million. Under his proposal, the limitation would be determined as of the end of a calendar year and would apply to contributions or accruals for the following calendar year. Plan sponsors and IRA trustees would report each participant’s account balance as of the end of the year, as well as the amount of any contribution to that account for the plan year.
For a taxpayer who is younger than 62, the accumulated account balance would be expressed as an annuity value by converting the accounts based on generally accepted actuarial assumptions. This theoretical annuity would come in the form of a 100% joint and survivor benefit using the actuarial assumptions that apply to converting between annuities and lump sums under tax-qualified defined benefit plans. For a taxpayer who is older than age 62, the accumulated account balance would be converted to an annuity payable in the same form, where actuarial equivalence is determined by treating the individual as if he or she was still age 62. In either case, the maximum permitted accumulation would continue to be adjusted for cost of living increases.
Plan sponsors of defined benefit plans would generally report the amount of the accrued benefit and the accrual for the year, payable in the same form.NEXT: What happens when cap is exceeded
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. If a taxpayer’s investment return for a year was less than the rate of return built into the actuarial equivalence calculation (so that the updated calculation of the equivalent annuity is less than the maximum annuity for a tax-qualified defined benefit plan), there would be room to make additional contributions. In addition, when the maximum defined benefit level increases as a result of the cost-of-living adjustment, the maximum permitted accumulation will automatically increase as well. This also could allow a resumption of contributions for a taxpayer who previously was subject to a suspension of contributions by reason of the overall limitation.
According to the proposal, any excess in accumulation would be treated in a manner similar to the treatment of an excess deferral in a defined contribution plan under current law. The taxpayer would be allowed a grace period during which the taxpayer could withdraw the excess from the account or plan in order to comply with the limit. If the taxpayer did not withdraw the excess contribution (or excess accrual), then the excess amounts and attributable earnings would be subject to income tax when distributed, without any adjustment for basis (and without regard to whether the distribution is made from a Roth IRA or a designated Roth account within a plan).
This same proposal has been submitted for years, with much backlash from industry groups. In addition, surveys show retirement plan participants are opposed to any changes to tax advantages of benefits.
Other proposals in the budget include limiting Roth conversions to pre-tax dollars and eliminating deductions for dividends on stock of publicly traded corporations held in employee stock ownership plans (ESOPs). More proposals in the “Loophole Closers” section of the budget can be found starting on page 160 of the IRS document.