Obama Proposes Putting a Lid on Retirement Savings Accounts
The $3 million cap sounds reasonable, but that's before doing the actuarial math.
Tucked deep inside President Obama's budget proposal to Congress is an innocuous-sounding provision that would cap the amount of money you can accumulate in IRAs and other tax-deferred retirement savings plans at $3 million. That cap, which would apply to an individual's total balance for all tax-preferred accounts, would affect less than 1% of current savers. But higher interest rates could significantly increase the number of people affected, the Employee Benefit Research Institute says.
The $3 million cap is based on the amount of money a retiree would need at current interest rates to buy an annuity that would produce $205,000 a year, which is the federal limit for defined-benefit pension plan annuities. The problem, EBRI says, is that the $3 million cap reflects record-low rates, which increases the cost of an annuity.
EBRI analyzed annuity prices going back to 2006 for a 65-year-old male and found that during that period, a $205,000 annual payout could be purchased for as little as $2.2 million. At that threshold, nearly 3% of all 401(k) accounts would be affected, EBRI says, and up to 6% of younger retirement savers (ages 25 to 36) would hit the cap by the time they reach age 65. For that reason, the $3 million cap "is really misleading," says Jack VanDerhei, research director for EBRI.
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Faced with a cap on tax-deferred accounts, some investors may shift some of their savings to taxable accounts—something savers who have maxed out their retirement savings plans already do. That isn't always a bad thing: Withdrawals from these accounts are taxed at capital-gains rates—currently a maximum of 20% for high-income taxpayers—versus ordinary income tax rates of up to 39.6% for withdrawals from traditional IRAs and 401(k) plans.
But VanDerhei points out that the cap would also be an "administrative nightmare" for small-business owners and could discourage them from offering retirement savings plans to their workers. Small-business owners can contribute much higher amounts to their tax-deferred retirement accounts than their employees—up to $56,500 in 2013. If their contributions are capped, they may have little incentive to set up a plan for their employees, the American Society of Pension Professionals and Actuaries says.
The retirement-savings cap is one of several provisions in the White House budget that target tax breaks used primarily by wealthy individuals. It would raise an estimated $9 billion in additional tax revenues over ten years.
Under current rules for retirement savings plans, the budget states, "some wealthy individuals are able to accumulate many millions of dollars in these accounts, substantially more than is needed to fund reasonable levels of retirement saving." One person who would have to stop funding his IRA if the proposal becomes law would be Mitt Romney, who during last year's presidential campaign revealed that his IRA was worth up to $100 million.
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