IRA Cap Gives Rise to New Funding Strategies

President’s proposal comes with silver linings for shrewd advisors

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“President Barack Obama’s proposal to cap tax-deferred retirement contributions at $3.4 million is raising a lot of questions among financial planners,” Kelly Greene understatedly wrote on The Wall Street Journal’s Total Return blog on Monday.

Full-fledged freak-out is more accurate.

“Curbing the growth of retirement plans in a nation where 91% have less than $100k saved is insanely ignorant,” financial planner, author and speaker Rick Kahler tweeted upon news of the plan, summing the sentiment of many in the advisor industry.  

Criticism of the overall budget was bipartisan, with Joe Lieber of Washington Analysis noting that “liberals are especially concerned about the president’s inclusion of chained CPI," a different measure of the consumer price index, "as a cost savings measure.”

But as with the Whac-A-Mole carnival game, new regulation often means new opportunity, and Greene pointed to two new funding strategies already making the rounds in social media forums.

The president’s budget proposal includes a lifetime cap on savings in individual retirement accounts and other tax-deferred savings vehicles, including 401(k) plans and profit-sharing plans.

“The reasoning is that a worker’s total account balance would be limited to the amount needed by a 62-year-old to buy an annuity generating an annual payment of $205,000,” she explained.

She said she heard from “dozens” of financial planners, estate-planning lawyers and savers themselves whose savings “hover close to that level” and are asking questions about how it would work.”

They include:

  • How would this be administered when you have hit the cap, but then the market value dips and you’re below it and can contribute again?
  • Would public employees face the same upper limit on their pensions? If they already have reached the $205,000 limit, could we stop making contributions for them? Or could they stop getting pension raises?
  •  What if you have a pension and other tax-deferred accounts? Who is responsible for aggregating the information? Who will pay that administrative cost?
  • How many people will be voting on this who have a pension greater than $205,000 a year?

Two strategies she says are being mulled.

“Advising your children to fund Roth IRA accounts, on which tax is paid upfront and withdrawals are generally tax-free after meeting holding requirements, early in life till they reach the cap, giving their investments more time to grow beyond the cap.”

The second is setting up a Roth IRA trust to follow another provision of the budget proposal, “emptying inherited accounts within five years of the IRA owner’s death. The IRA could be emptied into the trust, and then you could still require your heirs to take withdrawals over a longer period of time, if you’d rather them do that than be hit with a one-time windfall.”

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Read Estate Planning in the Age of Obama on AdvisorOne.

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