Retirement Changes Proposed by President Obama – 8/30/13

President Obama unveiled his budget proposal recently for the upcoming fiscal year, which begins on October 1st.  This also corresponds to the date the government is expected to run out of money and Congress will be forced to approve a continuing resolution to avoid a government shutdown.

Below are a few highlights of President Obama’s proposals that could have financial implications for our clients.  We do not necessarily believe these proposals will be implemented but we do feel it is important to be cognizant of what is being proposed.  

Mandatory IRAs – Under the administration’s proposal, employers that have more than 10 workers and have been in business for at least two years would face a new requirement to set up and provide automatic enrollment in IRAs for their employees.  Employees would contribute to the IRAs through payroll deductions.  In addition, they would be able to elect how much of their salary they wish to contrite to their IRAs (up to the annual contribution limit), or they could elect to opt out.  In absence of an employee election, 3 percent of an employee’s salary would be contributed to the IRA.

Emptying Inherited IRAs – Most beneficiaries of IRAs and other retirement accounts would be required to empty an inherited retirement account by the end of the fifth year of the original owner’s death, according to the administration’s proposal. (Presumably, required minimum distribution rules would apply, meaning the remaining balance would be subject to a 50 percent penalty – like all other missed required minimum distributions).

Savings Cap – New contributions to tax-favored IRAs and 401(k)s would be prohibited once clients exceed an established cap, under the president’s proposal.  This cap would be determined by calculating the lump-sum payment that would be required to produce a joint and 100 percent survivor annuity of $205,000 a year beginning when clients reach age 62.  (This formula would initially set the cap at $3.4 million).  Clients with cumulative retirement accounts in excess of this amount would be prohibited from contributing new dollars to retirement accounts on a tax-favored basis, although accounts could still grow as a result of earnings.  The cap would be increased for inflation.

A 28 Percent Maximum Tax Benefit – Another proposed change to tax benefits: The maximum tax deduction from making contributions to defined contribution retirement plans would be limited to 28 percent.  As a result, certain high-income taxpayers making contributions to retirement accounts would not receive a full tax deduction for amounts contributed or deferred.  For example: If you have more than $500,000 of taxable income and you currently defer $10,000 into a 401(k), you do not currently pay any income tax on that $10,000.  Without that tax deferral, the income would most likely be taxed at the highest effective marginal rate of 39.6 percent.  But if this proposal were to become effective, that $10,000 would effectively be taxed at 11.6 percent (39.6% minus 28%), since the maximum tax benefit a client could receive would be limited to 28 percent.  That would equate to an additional tax bill of more than $1,000.

Partial RMD Elimination – Clients with combined savings across all retirement accounts of $75,000 or less would be exempt from required minimum distributions.

Non-Spouse Rollovers – Non-Spouse beneficiaries would be allowed to move inherited retirement savings from one inherited retirement account to another through a 60-day rollover period – similar to the way they can currently move their own retirement savings.   The goal here would be to close the difference in treatment of spouse and non-spouse beneficiaries.

Investors Weigh U.S Response to Syria

U.S. equity markets fell this week and the S&P 500 has extended its worst monthly drop since May 2012, as investors weigh the implications of an American attack on Syria (S&P 500 is still up 14.86 percent year-to-date as of 8/29/2013).  The administration has yet to make a final decision on their response to Syria’s alleged use of chemical weapons against their own people and we will continue to monitor this situation closely as it develops.

Congress will also step back into the spotlight over the next few weeks as they will be forced to vote on another continuing resolution before September 31st.  Failure to get a new continuing resolution passed will result in a government shutdown.  Financial markets may experience some short term volatility during this process.  However, investors have experienced this dog and pony show in Washington before and the effect on investor confidence will most likely be diminished.