8 Threats for Retirement Accounts

While supporters of President Obama’s 2016 Fiscal Budget say the budget will make it easier to save for retirement, the proposal is giving mixed messages when it comes to retirement planning.  I have identified eight budget provisions that would have a negative impact to many retirement accounts.

1. Limit Roth Conversions to Pre-Tax Dollars – After tax money held in traditional IRAs or employer sponsored retirement plans would no longer be eligible for conversion to a Roth account. If this is passed it would mean that 2015 is the last year that federal employees under CSRS can convert their after-tax contributions to a Roth IRA.  Click here to learn more.
2. Eliminate the “Back-Door Roth IRA” – There are income limitations to contribute to a Roth IRA, which disallows higher earners to contribute to Roth IRAs. On the other hand, anyone that is earning income can contribute to a traditional IRA.  There are no income limits to convert to a Roth IRA, so an individual that is not allowed to contribute to a Roth IRA due to income limits, can contribute to a traditional IRA and then convert the IRA to a Roth IRA.  This is referred to the “Back-Door Roth IRA” method.
3. Eliminate the Special Tax Break for NUA – NUA (net unrealized appreciation) is a special tax break that would be eliminated. To be eligible for this tax break you must have appreciated stock of your employer or former employer inside the employer sponsored retirement plan.  Currently, there are rules allowing you to pay tax on this stock at long-term capital gains rates versus ordinary income tax.
4. Create RMDs for Roth IRAs – This proposal would require you to take RMDs (required minimum distributions) from a Roth IRA once you turn 70 ½, in the same way that you would do for a traditional IRA.
5. Create a 28% Maximum Tax Benefit for Contributions to Retirement Accounts – This is also a potential negative for high earners. Individuals in higher tax brackets, such as 33%, 35%, and 39.6%, would no longer receive the full tax benefit for amount contributed into a retirement plan.  The proposal would limit the maximum tax benefit you could receive for making a contributions to a retirement plan to 28%.
6. Establish a “Cap” on Retirement Savings Prohibiting Additional Contributions – Individuals would not be able to contribute to a retirement plan if contributions and accruals reached $3.4 million. While this may seem like a lot of money, it could end up impacting 10% of retirement plan participants.
7. Mandate 5-Year Rule for Non-Spouse Beneficiaries – Non-spouse beneficiaries would be forced to spend down their inherited retirement account five years after the owner’s death. (Currently a non-spouse beneficiary can take distributions from an inherited IRA over their lifetime using the IRS single life table). This provision would mean the end of the “stretch IRA’ and the tax benefits that come with it.  The proposal would not affect those who already have beneficiary IRAs, but would impact those who inherit in 2016 and beyond.
8. Diminish Aggressive Social Security Claiming Strategies – Eliminate the “file and suspend” strategy which allows married couples to take advantage of spousal benefits and delayed benefits simultaneously.

While there are positive provisions in the budget for retirement planning: protection of Social Security benefits, increasing retirement savings in employer sponsored plans, and giving workers automatic access to IRAs, the overall message is very conflicting.

 

Although the proposals are not yet fully explained, there are a few things you can do to prepare for these approaching changes.  There is a good chance the IRA rules will be grandfathered in existing IRAs and Roth IRAs, so setting them up now may prove to be a very good move.  If you are able to contribute to contribute after-tax money to an employer sponsored retirement plan and convert to a Roth IRA, you will want to take advantage of that this year.  Federal Employees still employed that are CSRS and do not owe any deposits or re-deposits can contribute no more than 10% of their lifetime earnings to the Voluntary Contribution Plan (VCP) and convert to a Roth IRA account at present.

 

It is essential that you stay educated, and watch out for new legislation.  If you find yourself in a position that the impending changes may affect you, plan and act now to prepare for those changes.

Carol Schmidlin, Founder

Carol Schmidlin does not provide tax and/or legal advice, but will work with your attorney or independent tax or legal advisor.  A qualified tax professional or independent legal counsel should review the tax implications of any securities transaction. This material is not intended to replace the advice of a qualified attorney, tax advisor, financial advisor, or insurance agent.  Before making any financial commitment regarding the issues discussed here, consult with the appropriate professional advisor.  Franklin Planning does not offer tax planning or legal services, but will provide references to accounting, tax services or legal providers. They will also work with your attorney or independent tax or legal advisor.

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