Are Changes to Retirement Plans Afoot?
Surveying the key retirement-planning aspects of President Obama's budget proposal for fiscal year 2017.
No more backdoor Roth IRAs. Required minimum distributions for Roth IRAs, but no RMDs for investors without a lot of retirement assets. No more Roth IRA contributions post-age 70 1/2.
Are those seismic changes to the retirement-planning landscape ready to rock your world?
Not just yet. While all were proposed as part of President Obama's budget for fiscal-year 2017, they're just that at this stage--proposals. In order to become law, they would need to wend their way through Congress first--an exceptionally high hurdle, especially this year.
"Tax legislation is not popular in an election year," said Michael Kitces, a partner and director of research for Pinnacle Advisory Group. (Kitces discussed the retirement-related proposals at length in a post on his Nerd's Eye View blog this past week.) "The short answer--and 'good news'--is that the odds any of this gets passed this year is virtually nil," Kitces said.
Roger Wohlner, a financial advisor and freelance writer based in Arlington Heights, Illinois, agrees that investors shouldn't rush to upend their financial plans based on proposals that may or may not come to pass. "I do not tend to pay too much attention to these proposals until they become reality," he said.
But Kitces warns that elements of the Obama budget proposal, especially those designed to close what are effectively loopholes in the tax code, could portend changes to the tax law that could be enacted down the line. "The list of 'crackdowns" are line items that could be added on short notice to other nontax legislation as a revenue offset," he said. "This is exactly how the 'Social Security crackdown' came to pass last year." (Popular Social Security filing strategies, including 'file and suspend,' are being phased out thanks to a bipartisan budget deal passed by Congress in late 2015. This article discusses the changes to Social Security filing strategies in greater detail.)
The possibility that some of these proposed tax changes could come to pass--if not right away, then down the line--makes them worth keeping on your radar. Interested readers can take a closer look at the specific proposals in the so-called (and surprisingly digestible) Treasury Greenbook. Here's a look at some of the most noteworthy ones that relate to retirement planning.
No More 'Backdoor' Roth IRAs
This maneuver, a popular one among high-income retirement savers, has been on the watchlist for a while; Obama's 2016 budget also included a provision that would effectively put an end to this maneuver. The backdoor Roth IRA sprang into existence in 2010, when Congress lifted the income limit on IRA conversions. While investors with income over certain levels (in 2016, $132,000 for single filers and $194,000 for married couples filing jointly) cannot make direct Roth IRA contributions, they can get money into Roth IRAs by opening traditional IRAs and then converting them to Roth. A proposal in the Obama budget would effectively kill the maneuver by allowing only pretax dollars in retirement accounts to be converted to Roth. (Contributions to backdoor IRAs consist of monies that have already been taxed.) Michael Kitces notes in a blog post that the proposal, if enacted, would also crimp the attractiveness of amassing aftertax dollars in a 401(k) with an eye toward moving the money into a Roth IRA at a later date. (I discussed aftertax 401(k) contributions in this article.) For now, the backdoor Roth IRA is still an allowable maneuver, but its days could be numbered.
Required Minimum Distributions From Roth IRAs
The president's budget proposal aims to impose required minimum distributions on Roth IRA holders; while traditional IRAs and 401(k)s--both Roth and traditional--are subject to RMDs, Roth IRAs are the holdout. Such a proposal, if enacted, could remove one of the key attractions for Roth IRA assets. In addition to being able to take tax-free withdrawals from their Roth IRA accounts, many affluent retirees like to amass Roth IRA assets because they don't require RMDs and the assets can continue to grow tax-free for their heirs. Kitces believes that investors can use the proposal to serve as fair warning as they craft their investment plans. "Don't overweight the value of a Roth conversion just to avoid RMDs," he advised.
Drop RMDs for Smaller Retirement-Account Holders
Also under the heading of simplifying RMDs, one of the proposals in the president's budget would allow investors with total tax-sheltered retirement assets of less than $100,000 at the beginning of the year in which they turn age 70 1/2 to skip RMDs altogether. In addition to being friendly to less-wealthy investors, this one wouldn't likely result in a big give-up in tax revenues, either. After all, many such small-account holders are likely liquidating their retirement accounts at a faster pace than the RMD rules require them to do; moreover, the taxation of the small accounts isn't bringing in a high dollar amount in absolute terms.
Put Limits on Large Tax-Advantaged Retirement Accounts
At the opposite end of the spectrum, the budget proposal includes a provision that would limit new contributions to tax-advantaged retirement accounts once an individual's total balances across all accounts surpassed $3.4 million. If this sounds familiar, you're not going crazy: A similar proposal surfaced as part of the president's budgetary plan for fiscal-year 2014, but it didn't get far.
No Post-Age 70 1/2 Roth IRA Contributions
For seniors who still have earned income after age 70 1/2 (say, from a part-time job) and who don't need their RMDs for living expenses, I've often suggested that they plow their unneeded RMDs into Roth IRAs to allow their assets to continue to enjoy tax-favored status. That strategy would go out the window with the enactment of a proposal in the president's budget, however, which would disallow Roth IRA contributions after age 70 1/2. Investors can't currently make traditional IRA contributions after age 70 1/2, either; so, as with the proposal to add RMDs to Roths, this one brings the rules on the two account types into sync. (Nor does it make too much sense to allow new contributions to an account at a time in your life when you're required to take mandatory distributions.)