A Cap on Tax-Sheltered Account Size?

Adam Zoll: For Morningstar, I'm Adam Zoll, and welcome to The Retirement Radar. Could the government put limits on the amount you're allowed to save in your 401(k) or IRA plan? Here to discuss it is Morningstar's director of personal finance Christine Benz.

Christine, thanks for being here.

Christine Benz: Adam, great to be here.

Zoll: So, as part of his budget, the president recently proposed capping IRA and 401(k) amounts for individuals. What is the exact proposal, and what impact do you think that will have on savers?

Benz: Well, I think proposal is the important word here, so it is just in a proposal phase. It has not made its way through Congress, has not been approved. But what the proposal would set out to do is to cap the amount that savers could hold in tax-sheltered retirement accounts. So that would be IRAs, 401(k)s, 403(b)s, 457 plans, and so forth.

And so it would cap that amount at $3.4 million, and they arrived at that figure by looking at the amount that a 65-year- old could purchase as an immediate annuity, and that amount would buy an annual benefit of roughly $205,000.

So, I would emphasize that this has not made its way through Congress at this point. There is a lot of, I am sure, discussion to be had over this matter. And one tension that it sets up is a tension between the asset management industry, which presides over IRAs and 401(k)s and so forth, and the insurance industry.

And the reason that you've got that tension is that the asset management industry, if there were such caps, would be affected. People presumably might seek out other options, places to put their money if they're looking to have some tax-saving benefits, and insurance companies could in fact be the beneficiaries.

So, life insurance proceeds, for example, are exempt from federal income tax; that might make life insurance policies look relatively more attractive. So, I expect to see a lot of tension, a lot of probably lobbying on the part of these two constituencies, before it's all over.

Zoll: And some estate planning ramifications for high-net-worth individuals here?

Benz: Absolutely. I would imagine that estate planning attorneys and financial planners are taking a hard look at this proposal and seeing if this might require some re-jiggering on the part of their client portfolios.

Zoll: Elsewhere in the budget, I know there was another proposal involving IRAs and inherited IRAs, in particular. Can you talk about that?

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Benz: So this looks at non-spouse beneficiaries of inherited IRAs, people who inherit IRAs, and they're not the spouse of the person who is deceased. And currently that non-spouse beneficiary has the ability to stretch out the payments from that IRA over his or her lifetime. This proposal would require these non-spouse beneficiaries to take the total IRA proceeds within a five-year period. So, it would be a big adjustment. This is another one that I would imagine estate planning attorneys are looking hard at right now.

Zoll: So, the required minimum distributions for an inherited IRA would be over a five-year period as opposed to the lifetime of the inheritor?

Benz: Exactly right.

Zoll: In other news involving retirement plans, the GAO also came out with the report this week that was about people rolling over 401(k) plans. What did that report say?

Benz: The Government Accountability Office took a look at the sorts of information that 401(k) plan participants are provided with at the time that they might be leaving their company. And what they found was that there wasn't great transparency for 401(k) participants about what to do with the money, and oftentimes what they found was that these participants were being kind of sold on sticking with the current provider.

So, even if they plan to roll over to an IRA that they would try to be sold into the same company that was managing the [401(k)]. So, they found a lot of confusion on the part of 401(k) participants overall. The report called for greater transparency for participants.

What I would say, Adam, though, is that generally speaking, for 401(k) participants who are leaving their employers really oftentimes rolling over it into an IRA rather than sticking with the company plan is the better option. It's going to be the lower-cost option, because typically with an IRA, even though you might have some fees, you typically don't have that layer of administrative expenses that usually accompany 401(k) plans.

So that's just a caution I would urge for anyone listening to this and hearing worries about these rollovers--usually the rollover is going to be your better option.

Zoll: And are there any advantages to rolling over into an IRA with the same provider? It's probably more convenient, but could there also be some cost hurdles to overcome to make that decision?

Benz: Possibly so. So, if your entrenched 401(k) provider is a high-cost provider, you would have a great disincentive to sticking with them. But if you have a gold-plated plan or a terrific provider, and you are able to get into very low-cost funds, there is certainly a convenience factor there.

Zoll: Another topic that is on a lot of retirees' and near-retirees' minds is long-term care insurance. We seem to be hearing more and more about that industry. But a recent report found that there may be some problems down the road, some sobering statistics involving long-term care. What have you heard about that?

Benz: That's right. So, everyone who is pre-retired or retired is very concerned about the cost of long-term care. The Wall Street Journal had a great report this week actually looking at a supply shortage of workers in this area, which I think is going to be a big headwind for this industry in the years ahead. So, the Journal laid out the demographics, and so right now in 2010, we had roughly 40 million people over the age of 65, by the year 2030 that's projected to be 73 million, so a big jump up in terms of the population that might need such long-term care.

And so, what the Journal report found was that this group of workers who provide care to people in long-term care settings, either at home or in a facility, tend to be older than the general population. They also tend to be underpaid or relatively lower paid, relative to other jobs, and they tend to get injured more frequently. So, it can be a hard job with lots of lifting and lots of physical demands, you combine that with an older workforce, and you've got problems.

So, one other thing that that we see in this industry, or that the Journal reported on, is the high rate of turnover among workers in this area. So, people become injured or otherwise disillusioned with their jobs in this industry and need to drop out. So, it's just kind of a really negative convergence. I think it argues for making sure that, if you're in the pre-retirement phase that you are giving due attention to long-term care planning, because it stands to reason that people of means, people who have purchased insurance or at least set aside pools of assets to pay for long-term care, will be in a better position to receive better care if they should need it.

Zoll: Right. That makes a lot of sense. Again, as you said, it's another reason for people to really have this on their own personal retirement radar and plan ahead for that.

Benz: Right.

Zoll: Christine, thanks for being here today and sharing your thoughts with us.

Benz: Thank you, Adam.

Zoll: For Morningstar, I'm Adam Zoll.