Younger workers would take brunt of Obama’s IRA curb

President Barack Obama’s proposal to curb individual retirement account accumulations is likely to take a toll on the savings of younger workers.
The provision, a part of the $3.77 trillion budget proposal for 2014, which was released today, would require that IRAs and other tax-preferred retirement savings accounts provide no more than $205,000 in annual retirement income. For someone retiring today, that would be a total of $3 million.
An analysis by the Employee Benefit Research Institute found that 1.2% of workers age 26 to 35 will be affected by the $3 million cap when using an age-based asset allocation. When using the amount of time these younger investors have to accumulate savings by the time they’re 65, 2.2% of those currently aged 26 to 35 will be affected.
The effect would be even more widespread when considering that the amount of money needed to hit the $205,000-per-year income limit can fluctuate over time because of discount rates. For instance, going back to 2006, the actuarial equivalent of a $205,000 annuity for a 65-year-old-male was as low as $2.2 million, according to EBRI. Higher interest rates could reduce the cap further.
At the $2.2 million level, 6% of those aged 26 to 35 will be affected by the time they hit age 65, compared with 0.3% of those in the 56 to 65 age bracket.
Advisers are mostly against the idea of capping the growth limits of IRAs. Though accounts that large are few and far between, rollovers out of 401(k)s could certainly spawn IRAs with millions of dollars in them, noted Robert K. Haley, president of Advanced Wealth Management. He disagreed with the concept of applying a cap on IRA accumulation.
“It can be counterproductive to put these limits on, because you encourage people to engage in either tax avoidance or tax evasion tactics,” Mr. Haley said.
Others worried that an initial cap could create a precedent for further limits on IRA accumulation. “There’s nothing stopping them from reducing that [$3 million] amount and saying that it’s $2 million or $1 million,” said Jason Hochstadt, executive vice president of Jedi Management Inc.
The American Society of Pension Professionals and Actuaries raised the concern that imposing such limits could discourage small employers from maintaining a 401(k) plan in the first place because they won’t have the tax-deferred incentive of saving for themselves.
“The frustration we feel is that small-business owners have been playing by the rules all along, complying with contribution limits and making contributions for workers, and now they’re being told they can’t save anymore because they’ve invested too successfully,” said ASPPA chief executive Brian H. Graff.
Even though EBRI’s report indicated that only a small number of individuals would be affected, the pain for them is real, he added. “A lot of those people are business owners,” Mr. Graff said. “People may lose out on the plan and have reductions in benefits. The proposal will raise $9 billion: That’s not just a couple of people.”
Still, others said that issue is workable if the Obama administration considers adjusting the required-minimum-distribution rules, indexing the cap and grandfathering in existing IRAs.
“You’re not keeping people from saving; you just can’t do tax-deferred saving over this amount,” said Kent Kramer, a wealth management partner at the Foster Group Inc.
A potential bright side could be that putting the IRA cap in place might encourage advisers to come up with new approaches to clients’ investment needs. Clients shouldn’t have a large concentration of their wealth in their IRAs, said Mr. Haley. Instead, they should be diversifying for tax efficiency when the time comes to withdraw.
“Advisers focus too much on tax deferral,” Mr. Haley said. “They don’t recognize the challenges for clients in retirement when 90% of their funds are in an IRA.”
Overall, the EBRI study found that only 0.03% of the 20.6 million retirement accounts in its IRA database had $3 million in assets as of the end of 2011.
On the 401(k) side, and based on the EBRI/Investment Company Institute’s 401(k) database, EBRI projected that about 0.004% of those accounts had $3 million or more in them by the end of last year.
Not surprisingly, a good chunk of the large IRA accounts belong to older individuals. Considering that some individuals hold multiple retirement accounts, only about 0.06% of all account holders surpassed the $3 million threshold. Of that, 36% were over age 70 and 20% were between ages 65 and 69.
When counting for combined IRA and 401(k) balances, some 0.11% of those over 60 had balances that totaled to $3 million.