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.
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.