"The Pension Specialists" Blog

Will 2014 be the last year for Traditional IRA Contributions

We hope not, but time will tell. A recently introduced tax bill, the Tax Reform Act of 2014 would make some drastic changes to IRA laws and pension laws.

One Congress is soon ending and another Congress will soon be starting. The current chairmen of the Tax and Ways Committee is Mr. David Camp. He has proposed many major tax, law changes in a proposed tax bill, the Tax Reform Act of 2014.

This article discusses these proposed IRA changes. The adjacent article will discusses the pension changes.

Not too many politicians are willing to expressly promote that major changes be made to social security, but it will be interesting to see whether they are willing to change the IRA and pension laws which have existed for 40 years. Individuals have relied on the tax laws in deciding to make contributions. Many of the tax laws require a mandatory increase in various IRA/pension limits to reflect the impact of inflation. These mandatory increases result in less revenue being available to the federal government.

As with any law, Congress and the President may always change a law, whether it be social security or IRAs or pensions. Congressional representatives are always looking for new or additional sources of revenue. This is as true today as it was in 1986 when the decision was made to take away the right of many taxpayers to make tax deductible contributions. Prior to 1987, individuals contributed 35 billion dollars of deductible contributions, but that amount has now deceased to around 12 billion per year. Many individual are contributing to their employer’s 401(k) plans and not making contributions to their traditional IRAs. Existing law allows a person to do both.

What are the IRA changes within the proposed Tax Reform Bill of 2014? Except as stated otherwise, the new laws would be effective for the 2015 tax year.

Proposed change #1. All taxpayers with compensation will be eligible to make an annual Roth IRA contribution. Under existing law, individuals who incomes are “too high” are ineligible to make an annual Roth IRA contribution.

Proposed change #2. The right to make annual traditional IRA contributions is repealed. This includes both deductible and nondeductible contributions.

Proposed change #3. The 2014 and 2015 IRA contribution limit is $5,500 if under age 50 and $6,500 if age 50 and older. This limit is to be adjusted by a cost-of-living adjustment of $500 when the accumulated change is $500. This adjustment would be suspended until 2023.

Proposed change #4. The special rules applying to the withdrawal of traditional IRA and Roth IRA funds if used for a first-time home purchase would be repealed. Withdrawing funds from a Roth IRA for a first-time home purchase would no longer be a qualified (tax-free) distribution. And taxable funds withdrawn from either a traditional, SEP, SIMPLE or Roth IRA by a person under age 59½ would be subject to the 10% additional tax.

Proposed change #5. The right for an employer to establish a new SEP-IRA plan is repealed as of December 31, 2014. However, an employer with a SEP as of December 31, 2014 is grandfathered and is allowed to continue its SEP plan as long as such plan meets the existing requirements for such plan year and every year thereafter.

Proposed change #6. The right for an employer to establish a new SIMPLE-IRA plan is repealed as of December 31, 2014. However, an employer with a SIMPLE- IRA plan as of December 31, 2014 is grandfathered and is allowed to continue its SIMPLE-IRA plan as long as such plan meets the existing requirements for such plan year and every year thereafter.

Proposed change #7. Under existing law the amount of compensation used to determine a person’s maximum SEP-IRA contribution is $210,000 with a maximum contribution amount of $52,000. This limit is to be adjusted by a cost-of-living adjustment, but only if the adjustment is $1,000 or any multiple of $1,000. For example, the maximum contribution for 2015 will be $53,000 if this proposed change is not adopted. This annual adjustment would be suspended until 2023.

Proposed change #8. Under existing law the maximum deferral amount for 2014 is $12,000 if a person is under age 50 and $14,500 if the person is age 50 or older. These limits are to be adjusted by a cost-of-living adjustment but only if the adjustment is $500 or any multiple of $500. For example, the maximum limits will be $12,500 and $15,000 for 2015 if this proposed change is not adopted. This annual adjustment would be suspended until 2023.

Proposed change #9. Current law permits a person to recharacterize an annual contribution and also to recharacterize a Roth IRA conversion contribution. In the case of annual contribution it allows a person who has made a traditional IRA contribution to switch it to be a Roth IRA contribution or vice versa. In the case of a Roth IRA conversion contribution it allows an individual to un-do it for any reason. The proposed law would repeal the law authorizing rechacterizations. Why?

When one recharacterizes a prior Roth IRA conversion, the federal government will not collect the tax revenues which would have been paid if the individual was unable to un-do the conversion. That is, a conversion once made would be irrevocable.

With respect to recharacterizing a current year contribution, the administrative work for IRA custodians and the individual are very labor/paper intensive and complex for all parties involved, including the IRS. In order to simplify IRA administration, the proposal is to revoke such rules. Being able to do a recharacterization can be quite beneficiary for an individual, so CWF would have a less extreme suggestion. Allow the IRA custodian to charge reasonable fees to process a recharacterization.

The recharacterization rules give an individual substantial flexibility in planning and executing various transactions. Some people feel the law is too generous and that individuals should not be granted such planning flexibility.

Proposed change #10. Current law allows a beneficiary to withdraw his/her required distributions over his/her life expectancy. For example, a beneficiary age 39 would be able to take RMDs over a 43 time period. The new law would define the new general RMD rule to be – the beneficiary must use the 5-year to determine his/her RMDs. That is, all funds within the inherited IRA must be distributed by December 31 of the fifth year following the year the IRA owner died. An individual will almost always pay larger tax bills than is the case under existing law. The federal government will be able to collect more taxes much sooner than under existing law.

Mr. Camp, as apparently many other representatives, has concluded that too much tax revenue is being deferred too long by allowing an inheriting IRA beneficiary to be able to stretch distributions over his/her life expectancy. Unless taxpayers inform their representatives that they will not tolerate this change, this type of change is coming. The representatives may be thinking that most beneficiaries are in their 30’s or 40’s. The reality is, most beneficiaries are in their 50’s, 60’s or 70’s and they will have a desire to use such funds for their retirement. More IRA accountholders are living into their 80’s and 90’s. Under current IRS rules, a beneficiary has his/her RMD calculated using the life distribution rule unless he/she is able to and does elect to the 5-year rule. Some beneficiaries called eligible beneficiaries will still be able to use the life distribution rule. For many beneficiaries, the use of the life distribution rule is repealed.

If a person meets any of the following requirements as of the IRA owner’s death, he/she is an eligible beneficiary:

1. He/she is the surviving spouse;
2. Disabled
3. Chronically ill
4. An individual who is not more than 10 years younger; or
5. A child of the IRA owner who has not yet attained age 22.

As under existing law a spouse beneficiary who is the sole beneficiary is not required to take a distribution until December 31 of the year the deceased spouse would have attained age 70½. And if he/she dies before such date, the surviving spouse is treated as the IRA for the purpose of determining the required to be made to the beneficiaries of the surviving spouse.

A beneficiary who is the child of the IRA owner will generally not be an eligible beneficiary and will be required to deplete the inherited IRA using the 5-year rule. The exception is when the child beneficiary is not yet age 22. A child is no longer an eligible beneficiary once he/she attains age 22. The 5-year rule will then apply. The 5-year rule will always apply once an eligible beneficiary dies.

The new rules would apply to an IRA owner dying after December 31, 2014.

For those beneficiaries of an IRA owner who died or dies before January 1, 2015, the current RMD rules continue to apply. However, upon the death of such a beneficiary the 5-year rule will apply and the next beneficiary must withdraw his/her share by the end of the fifth year after the death of the beneficiary.

Of course, the insurance companies have been lobbying the law makers so that certain IRA annuities will not be subject to the 5-year rule and will be paid out over longer time periods. That is, once the IRA owner dies the beneficiary will not be required to close the IRA annuity under the 5-year rule.

In the case of an IRA owner who dies after December 31, 2014, the 5-year rule does not apply to any qualified annuity that is a binding annuity contract in effect on the date of enactment and all times thereafter. An annuity must meet three requirements to be a qualified annuity. First, it must be a commercial annuity. Secondly, it must provide annuity payments which are substantially equal periodic payments not less frequently than annually over the joint life expectancy of the IRA owner and the designated beneficiary according to RMD rules for annuities in effect on the date of enactment. Third, annuity payments must have commenced to the IRA owner before January 1, 2015 and the IRA owner must have irrevocably elected before January 1, 2015, the method and the amount of the annuity payments to the IRA owner or any designated beneficiary.

An IRA annuity which is not a qualified annuity solely because annuity payments have not started irrevocably before January 1, 2015, may still be a qualified annuity if the IRA owner had made an irrevocable election before the date of enactment as to the method and amount of the annuity payments to the IRA owner or any designated beneficiary.

IRA annuities which have already commenced distribution to an inheriting beneficiary will not be subject to the 5-year rule and will be able to stay in existence and be paid out according to the terms of the annuity.

The above proposals are just proposals. But when the chairman of the ways and means committee is supporting them they must be taken seriously. Although the federal government needs additional tax revenues, gaining such revenues by changing the rules so radically after 40 years with little or no public discussion or guidance is unwise and unfair. I

One will need to ask the politicians why they are so willing to radically change the rules applying to IRAs and pension plans. Most politicians would not dare to make similar changes to the social security laws. CWF suggests that individuals communicate to Congress and the President that the proposed changes are too radical. CWF’s suggestion: leave existing law alone or if a change is needed substitute a 15 or 20-year rule for the proposed 5-year rule.