"The Pension Specialists" Blog

Election Day November 8th, 2016 and the Politics of IRAs.

You and other voters will go the voting booth on November 8th, 2016.

IRAs are political because they are created by the federal income tax laws. IRA owners receive tax preferences for making various types of IRA contributions or because the IRA has received a direct rollover or rollover contribution from a 401(k) plan or another employer sponsored retirement plan.

The federal deficit is a political issue waiting to be addressed. More and more politicians are starting to seriously look at IRAs and 401(k) plans as sources of tax revenues. Money in traditional, SEP and SIMPLE IRAs is tax deferred, it is not tax-free. When distributed or withdrawn, the distribution amount must be included in the recipient's income and tax paid at the person's applicable marginal income tax rate.

There is approximately 7.2 trillion dollars in traditional IRAs. Assuming an average marginal tax rate of 20% the federal government is looking to collect 1.4 trillion dollars from future IRA distributions. There is approximately 6.8 trillion dollars in 401(k) and other defined contribution plans. Assuming an average marginal tax rate of 20% the federal government is looking to collect 1.3 trillion dollars from future 401(k) distributions. The federal debt is estimated to be 19.5 trillion dollars as of September 30, 2016. IRAs and 401(k) plans cover 13.8% of the federal debt.

The question is, when will these tax revenues be collected?

Some politicians are starting to suggest the IRA rules need to be changed so the federal government starts to collect tax revenues sooner than under existing law.

Senator Ron Wyden represents the State of Oregon. He is a Democrat. There is a 50% chance he will become the chairman of the Senate Finance Committee in 2017 after the November 8th elections. He recently communicated that he and other Democrats will be pursuing the following IRA law changes.

1. With respect to inherited IRAs, the 5-year rule would apply once an IRA owner dies. This would be a monumental change. A traditional IRA beneficiary would have 5-6 years to take distributions, include such amounts in income and pay tax. The ability to stretch out distributions over the beneficiary's life expectancy would be repealed. A Roth IRA beneficiary would lose the right to have the Roth IRA earn tax-free income for a period equal to his or her life expectancy. The beneficiary would be given only 5-6 years of tax-free income
2. It is unclear if everyone would lose the right to make Roth IRA conversion contributions or if a person with traditional IRA funds could make a conversion contribution but only to the extent the IRA funds are taxable. That is, a person with basis in his/her IRA or pension plan could not convert any basis. The Obama administration has previously proposed not allowing basis within an IRA to be converted. A total repeal of the right to make a Roth IRA conversion contribution would be radical.
   
   At least on a short term basis, the federal government likes it when individuals make Roth IRA conversion contributions as tax revenues are collected.
   
   
3. There would be a new tax rule stipulating that the maximum value of a person's Roth IRAs would be limited to $5,000,000 and if this limit was exceeded then the excess would have to be withdrawn. This also would be a radical change.
4. A non-IRA change would be to change the law governing 401(k) plans. Somehow a person making student loan payments would be given credit under their 401(k)plan so that the loan payments would be treated as an elective deferral contributions so that an employer would have to make a matching contribution.

In summary, IRAs are political. As with other political subjects, each person will need to make their own voting decisions. Taking away IRA tax preferences is in essence a tax increase and individuals will need to decide the degree it will influence how they will vote. We at CWF believe switching to the 5-year rule for an inherited IRA beneficiary should be unacceptable.