NAFCU Services Blog

May 18, 2014 by Dennis Zuehlke
Categories: Compliance

Obama Budget Proposes Significant Changes to Roth IRAs

Originally posted on cuinsight.com.

Guest post written by Dennis Zuehlke, Compliance Manager, Ascensus

Ascensus is the NAFCU Services Preferred Partner for IRA, Retirement Plan, and Health Savings Account (HSA) Solutions Software, Training, Documents and Consulting.

The Obama administration’s fiscal year 2015 revenue proposal would make significant changes to Roth IRAs. If implemented, these changes would make the Roth IRA a less attractive savings vehicle for many—and have a significant impact on credit union IRA programs.

The Administration has proposed “harmonizing” the required minimum distribution (RMD) rules for tax-favored retirement accounts that would—in a game-changing move—subject Roth IRAs to the same RMD rules as Traditional IRAs. The proposal would require Roth IRA owners to begin receiving RMDs in the year that they attain age 70½, eliminating one popular reason for converting a Traditional IRA to a Roth IRA: to avoid RMDs. It also would diminish the amount of assets Roth IRA owners would be able to pass along to their heirs—tax free—in a Roth IRA.

Also, like Traditional IRAs, the Administration proposes to no longer permit Roth IRA contributions after age 70½. This would negatively affect Roth IRA owners age 70½ and older who are permitted to make Roth IRA contributions under current law.

Over time, these changes would generate additional tax revenue for the federal government, as assets are moved out of Roth IRAs and into accounts that would generate taxable income .

Also included in the fiscal year 2015 budget proposal were all of the retirement savings proposals from the fiscal year 2014 revenue proposal, none of which were enacted into law last year. Not included was the President’s myRA proposal, which the Treasury Department is already working to implement under an executive order that does not require congressional approval.

In a mid-term election year, and with a divided Congress, few expect that any of these proposals will become law this year. But the proposals should not be overlooked, as they could be enacted in future years, or as part of a comprehensive tax reform.

Following is a summary of the other major retirement savings proposals in the Obama administration’s fiscal year 2015 revenue proposal.

Automatic IRA Option

The Administration’s proposal would require employers in business for at least two years that have ten or more employees to offer an automatic IRA option. Employers sponsoring a qualified retirement plan, SEP plan, or SIMPLE IRA plan would not be required to offer an automatic IRA option. Under the Administration’s proposal, regular contributions would be made to an IRA on a payroll-deduction basis. The employer’s role would be to facilitate employee contributions using its existing payroll-deduction system, but no employer contributions would be required.

Cap on Tax-Advantaged Retirement Savings Plan Accumulations

Under this proposal, contributions to tax-advantaged retirement savings plans (such as IRAs, 401(a) plans, 403(b) plans, and governmental 457(b) plans) would be prohibited for individuals who have accumulated assets past a certain threshold. That threshold is the amount necessary to provide the maximum annuity permitted for a tax-qualified defined benefit plan (currently $210,000). For an individual age 62, this is approximately $3.2 million.

Limit on Tax Deductibility of Retirement Plan and IRA Contributions

Another proposal would limit the tax value of specified deductions or exclusions from adjusted gross income (AGI) and all itemized deductions.

The proposal would reduce the tax value of the exclusion for contributions from the full 33 percent, 35 percent, or 39.6 percent (depending on the individual’s tax bracket) to a maximum of 28 percent. Taxpayers in the 28-percent and lower brackets would be unaffected. This same provision also would limit the tax value of contributions made by these higher-income taxpayers to health savings accounts and Archer medical savings accounts.

Limit Payout Options for Nonspouse Beneficiaries

Another proposal would require nonspouse beneficiaries of retirement plans and IRAs to take distributions over a shorter period of time. Under current law, depending on the IRA owner’s age at the date of death, nonspouse beneficiaries may be able to take payments over their own life expectancies. As proposed, most nonspouse beneficiaries would be required to take distributions over a period of no more than five years, with exceptions for certain eligible beneficiaries.

Allow Nonspouse Beneficiary Rollovers to Inherited IRAs

The Obama administration also has proposed to allow nonspouse beneficiaries to roll over inherited plan or IRA assets to an inherited IRA within 60 days of receipt.

Under current law, a nonspouse beneficiary can only directly roll over employer-sponsored retirement plan assets, or transfer IRA assets, to an inherited IRA. If the nonspouse beneficiary receives the assets from the employer plan or IRA, the beneficiary cannot roll over the assets to an inherited IRA. This results in a taxable distribution to the nonspouse beneficiary.

Eliminate Required Minimum Distributions

Another proposal would eliminate RMDs if the aggregate value of an individual’s IRA and other tax-favored retirement plan accumulations does not exceed $100,000 on a measurement date. The RMD requirements would phase in ratably for individuals with aggregate retirement benefits between $100,000 and $110,000.

In Summary

The move to cap retirement plan balances and trim retirement tax incentives reflects the Obama administration’s belief that retirement savings tax incentives are skewed to favor the wealthy and should be more focused on lower- and middle-class taxpayers. The Administration also believes that retirement savings tax incentives are designed primarily to provide retirement security for participants and their spouses, not to transfer wealth to their beneficiaries. The President’s proposals are consistent with the themes outlined in his State of the Union address and are likely predictive of the President’s retirement savings policy for the remainder of his second term.

As previously stated, few expect that any of these proposals will become law this year. But the proposals should not be overlooked. They serve as a reminder that both the Obama administration and Congress are scrutinizing retirement savings incentives, and increasingly are viewing changes to retirement savings incentives as a way to generate additional revenue for the Treasury—without the stigma of actually raising taxes.

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