Congress May Restructure Your Retirement Accounts
President Biden recently presented the Build Back Better Plan. This is a multi-trillion dollar spending proposal that provides a Covid-relief package, an infrastructure and jobs plan, and an investment strategy for childcare and education. Having had a first pass through the House’s Ways and Means Committee, Congress has sent it back with a number of mark-ups. These mark-ups cover a lot of ground, and some are even game changing. Here we are going to focus on those that affect the retirement system. Let’s break down the legalese and see what these suggestions mean practically for U.S. workers.
- “Sec. 138301. Contribution Limit for Individual Retirement Plans of High-Income Taxpayers with Large Account Balances.”
The Idea: Retirement plans are meant to encourage workers to save for retirement. They are not meant to enable a tax-advantaged loophole for wealthy individuals to grow more wealth. Congress wants to stop subsidizing retirement accounts that are clearly in the “wealthy” range.
The Plan: Prohibit retirement investors from making contributions to retirement accounts that have exceeded the $10 million mark. This prohibition would apply to single taxpayers making more than $400,000/year or married taxpayers with taxable income over $450,000.
- “Sec. 138302. Increase in Minimum Required Distributions for High-Income Taxpayers with Large Retirement Account Balances.”
The Idea: Actively shrink retirement accounts that have accumulated an excessive amount of funds.
The Plan: Require a RMD (Required Minimum Distribution) from all retirement accounts that exceed $10 million. The amount of this RMD would usually be 50% of the amount that exceeds the $10 million limit. This RMD would be required every year when the total account accumulation from the year before exceeded the limit.
A further element of this plan kicks in if the aggregate value of the individual’s retirement accounts is in excess of $20 million. In such a case, the RMD is mandated to come from any Roth components (if present.)
- “Sec. 138311. Tax Treatment of Rollovers to Roth IRAs and Accounts.”
The Idea: Roth IRAs contributions are limited to workers under a certain income. Currently (2021) the income limits range from $125,000 – $140,000. Anybody making more than $140,000 is not eligible to contribute to a Roth. In 2010 Congress passed a workaround to this rule by allowing for Traditional IRAs to be converted into Roth IRAs, irrespective of the income level of the account holder. In other words, a high-income individual could contribute to a Traditional IRA and then roll those funds over into a Roth. Congress now wants to get rid of this workaround.
The Plan: Income limits will stay in effect for contributions to a Roth IRA. Rollovers will now also get an income limit of $400,000 for single taxpayers and $450,000 for married taxpayers filing jointly. Anybody whose income exceeds that limit will not be allowed to convert a Traditional IRA into a Roth.
- “Sec. 138312. Prohibition of IRA Investments Conditioned on Account Holder’s Status.”
The Idea: Certain investments are limited in the fact that they can only be offered to accredited investors. (An accredited investor is one who has an income of at least $200,000 or a net worth of $1 million.) These investments are not as heavily regulated, don’t have the oversight of a standard public offering, and may be risky. While limiting these investments to accredited investors will normally protect mom-and-pop investors from fraud, it can occasionally serve as a cover for really good investments that are only offered to a select few. These sweetheart deals have the ability to offer massive returns and Congress wants that they shouldn’t take advantage of a tax-free retirement account.
The Plan: Prohibit IRAs from holding any investments that are only offered to accredited investors. Any IRA which is found to be holding such an investment will lose its IRA status which will trigger tax liabilities and fees.
- “Sec. 138313. Statute of Limitations with Respect to IRA Noncompliance.”
The Idea: Individuals looking to take advantage of IRA rules often do so illegally, but are never subsequently penalized. The reason for this is that the statute of limitations for IRA noncompliance is a short three years. Congress wants to expand the time frame to allow the IRS more time to address violations.
The Plan: Expand the statute of limitations for IRA violations from 3 years to 6 years.
- “Sec. 138314. Prohibition of Investment of IRA Assets in Entities in Which the Owner Has a Substantial Interest.”
The Idea: One of the well known tenets of IRAs is the concept of Prohibited Transactions. In short this means that a Disqualified Person (the IRA account holder, a close linear relative, or a fiduciary for the account) may not receive or give any benefit to the IRA. This rule is meant as a means to prevent self-dealing in an IRA and unfairly taking advantage of its tax deferred status. The current regulations also address a situation where a Disqualified Person owns shares in a company that does business with the IRA. If the Disqualified Person owns at least 50% of the company, then the company is prohibited from engaging with the IRA. The current Congress feels that 50% is too low a threshold and still allows for significant self-dealing.
The Plan: Lower the ownership percentage to allow for more companies to be considered off limits to retirement accounts. The percentage of ownership that would disqualify the company would be lowered from 50% to 10%.