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Retirement Planning > Saving for Retirement > IRAs

6 Tax-Law Time Bombs Affecting IRAs

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The 2017 Congressional budget proposal includes six little-known but important tax time bombs that could affect your clients’ individual retirement accounts.

Joe Ross, vice president of sales productivity and business development for American International Group Life and Retirement, outlined these tax proposals and what they could mean for your client during a workshop on Wednesday at the National Association of Independent Life Brokerage Agencies’ annual conference in Dallas.

Ross noted it will be interesting to see the influence a new president will have on the overall budget, and whether these individual tax proposals will remain under the new administration.

“It’s not necessarily true that what we are talking about today will change under a new administration,” Ross said, “because this is not the Obama administration’s budget proposal, it’s the Congressional budget proposal.”

(Related: 18 Reasons Americans Are Afraid to Retire)

He said most people don’t know about these tax proposals because they are not law, but the fact that some of them have been showing up in proposals for six or seven years suggests there as at least some momentum driving a few of them forward. “I think some of this is just a question of time.”

One of the themes of many of the IRA-related tax proposals that continue to surface in budget proposals is that they target wealthy investors, said Ross.

“These are not things that are going to affect the small investors,” Ross said. “This is going after the people that have the money, and that’s partly because we’ve got a $20 trillion debt and we’ve got about $10 trillion worth of IRA assets out there. To have $10 trillion in IRA assets out there that are fully taxable, you can see there’s a huge opportunity for the IRS to pick up a significant amount of tax revenue here.”

Keep reading for six budget proposals Ross outlined that could affect IRAs…

Eliminate the ability for non-spouse beneficiaries to stretch IRAs

Currently, beneficiaries have the option of taking an inherited IRA via a lump sum or through stretching. (Photo: iStock)

1. Eliminate the ability for non-spouse beneficiaries to stretch IRAs

Current rules allow beneficiaries to take required minimum distributions based on their life expectancy. The younger the beneficiary, the lower the required minimum distribution, which allows more funds to remain in the account over time.

The language of the proposal to eliminate stretching says: “The RMDs are designed to prevent taxpayers from leaving these amounts to accumulate in tax-exempt arrangements for the benefit of the taxpayer’s heirs.”

“It could not be more painfully clear that the IRS has taken the position that they want to make sure that IRAs are preserved for the investor, but they don’t care what happens when it moves onto the next generation and they are prepared to take their pound of flesh,” said Ross.

The benefit to the IRS of limiting stretching is that it accelerates revenues flowing into the IRS and it creates a situation where beneficiaries are likely to be forced into taking a lump sum distribution right at a time when they are in their peak earning stage, which could push them into a higher tax bracket and create additional tax revenues for the IRS.

Retirement investments

Proposed rules could eliminate back-door Roth IRA strategies. (Photo: iStock)

2. Impose required minimum distributions on Roth IRAs

This proposal, which has been in Congressional budget proposals for six years, would require people to take required minimum distributions from their Roth IRAs. Why would the IRS want to force people to withdraw a minimum amount per year from their Roth IRA?

Because retirees would be more likely to spend that money, which is good for the economy, said Ross. But also because they would be more likely to remove money from a tax-sheltered vehicle and re-invest in a nonqualified vehicle, which would generate additional tax revenues, he said.

3. Eliminate back-door Roth IRAs

Back-door Roth IRA contribution schemes exist basically to allow those who earn too much to contribute to a Roth IRA to still reap the advantages of a Roth.

Married couples filing jointly who make more than $194,000 per year can contribute to a traditional IRA but can’t benefit from tax deductions on them. The same couple would not be allowed to contribute at all to a Roth IRA because of their income, said Ross. To circumvent this, investors will sometimes put money into a traditional IRA that has been fully taxed and then immediately do a Roth IRA conversion, which would not be taxed.

The IRS wants to put a stop to these back-door methods in this proposal, said Ross.

Many in government would like to see net unrealized appreciation rules repealed. (Photo: iStock)

Many in government would like to see net unrealized appreciation rules repealed. (Photo: iStock)

4. Repeal net unrealized appreciation rules

Net unrealized appreciation rules, which allow employees to hold stock in the company you work for within your 401(k) plan, have been on the books since 1956, but the government would like to see them repealed.

The benefit of net unrealized appreciation rules is that those 401(k) assets are not subject to required minimum distributions and income taxes. By holding the company stock until retirement and then moving it to a nonqualified brokerage account, net unrealized appreciation rules specify that the investor only has to pay taxes on the amount paid for the stock, not the in-plan appreciation amount, which could be significant.

5. Impose maximums on IRA funding

Calling this rule scary and another designed to go after larger investors, Ross explained that the IRS essentially has determined an amount it believes retirees will need to save in order to fund a lifetime annuity.

The budget proposal then says that investors would not be able to save in excess of that amount in a retirement plan.

The proposal would not force investors to take money out of their plan but could throttle the amount younger investors can put in, which puts them at a disadvantage in terms of access deductions and company matches.

This proposal has also been in budget documents for six years, said Ross. (Photo: iStock)

This proposal has also been in budget documents for six years, said Ross. (Photo: iStock)

6. Eliminate RMDs on IRAs with less than $100,000 in assets

On the surface, it appears to give investors with a lower amount of assets a break in terms of how much they have to withdraw. In reality, investors with smaller retirement accounts are more than likely already pulling out more than the required minimum distribution just to meet their basic needs, Ross said. 

Whether these items will make it into the next budget proposal under the new administration will be interesting, said Ross. We will find out in February.

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