Register For Our New Online Classes!

Obama's budget proposals and what they mean for IRAs

Obama's tax proposals suggest policy updates for IRAs that would making it harder to pass assets on to heirs tax free.

Some provisions in President Barack Obama's fiscal year 2015 budget proposal are not popular among financial institutions or consumers, especially the proposed changes to individual retirement accounts.

According to Credit Union Insight, the president's changes would make Roth IRAs a less attractive option for Americans to save for the future. Obama specifically proposed to make the required minimum distribution (RMD) rules uniform for both Roth and traditional IRAs by requiring that account holders begin receiving RMDs in the year they turn 70 and a half. This would perturb many Roth investors, as one of the key advantages of these savings plans is that they can avoid RMDs, which allowed them to use their account to pass assets on to their heirs tax free.

In addition to setting a start point for RMDs, the age threshold would also establish a cut-off point for making contributions.

"The Obama team put this out in an effort to simplify tax law when it comes to retirement accounts," Matt Curfman, a financial planner with Richmond Brothers Inc. in Jackson, Mich., told the American Association of Retired Persons. "Thank you, but no thanks. … It takes away from the planning benefits."

Under current law, account holders can allow their money to grow for more years if they don't need it in retirement. Obama's proposals would bar this advantage, lessening the total interest an account holder could accrue.

"If people are able to save and can save a lot of money in retirement, I don't understand why that is a bad thing," Curfman said.

Threshold would be created for maximum tax-advantaged accruals
In addition to establishing an age cap for IRA contributions, a limit would be introduced for accruals in tax-advantaged accounts, including IRAs, governmental 457(b), 401(a) and 401(b) plans. The cap would be set at $210,000, the current amount necessary to provide the maximum annuity permitted for a tax-qualified defined benefit plan. CU Insight noted that this is approximately $3.2 million for a 62-year-old individual.

RMDs could be eliminated
Obama also included a provision that could eliminate RMDs. The only requirement would be that the aggregate value of an account holder's IRA and other tax-favored retirement plan accumulations are less than $100,000 on a measurement date. Individuals who already have an aggregate value between $100,00 and $110,000 would have the new RMD rule phased in ratably.

Jeffrey Levine, a certified public accountant and IRA technical consultant with Ed Slott and Co., told AARP that this provision could be beneficial to Americans with modest 401(k) plans and regular IRAs, although most people in this group are likely to take distributions anyway.

Automatic IRAs from employers
Certain employers would also be implicated by Obama's IRA proposals, as they will be required to enroll their employees in IRAs automatically if they meet two conditions: Having been in business for at least two years and 10 or more employees. Using the employers' existing payroll deduction systems, regular employee contributions would be made. However, there would be no employer contribution and employers offering qualified retirement plans, SIMPLE IRA plans or simplified employee pension plans would be exempt.

Changes for nonspouse beneficiaries
The budget proposals included two provisions that would affect nonspouse beneficiaries: Distributions would have to be taken over a shorter time, and inherited plan or IRA assets could be rolled over to an inherited IRA within 60 days of receipt.

Current law allows for distributions to be based on a nonspouse beneficiary's life expectancy depending on the account owners age at the time of death. Obama's proposals, however, would cap the distribution period at five years, allowing exceptions for eligible beneficiaries.

Limits would be imposed for tax deductions
Tax benefits for retirement plan and IRA contributions would see another change as a result of a provision that would limit the tax value of specified exclusions or deductions from adjusted gross income and all itemized deductions. There are currently three exclusion values based on a taxpayer's income bracket: 33 percent, 35 percent or 39.6 percent. These groups would be consolidated, capping the tax value for exclusions for contributions at 28 percent, having a noticeable effect on high-income individuals.

Some say the wealthy would be favored
Some critics of the proposals have said that the president's plan benefits the country's wealthiest members while hurting low- and middle-income individuals. Although they are troubling for some groups, Obama's budget proposals don't have a strong track record for passing in Congress, and Levine noted that most of the provisions will require Congressional insight.

For this reason, it is not expected that the proposals will make noticeable headway by the end of 2014. However, CU Insight asserted that they should not be ignored, as they serve as a reminder that both Congress and the Obama administration are looking at ways to reform retirement savings incentives.