IRA Crackdown Talk in Congress Is All Bluster

IRA data released from the Joint Committee on Taxation revealing some mega-million dollar IRA and Roth IRA balances has set off alarm bells, with Congress citing shock and “abuse” and looking for something to do about this. But there is really no story here when you look at the numbers. This is a non-issue. Here’s why.

First, there is no abuse since the funds contributed to these IRAs were under the legal limits (unless they know something we don’t and that would be for IRS or courts to decide). These people followed the rules available to everyone.

It is not a growing problem. In fact, it’s a growing benefit for Uncle Sam (see why in the paragraphs below).

'Mega-IRAs' Long Overdue for a Crackdown: Senate Finance Chair

While this data, released by Senate Finance Committee Chairman Ron Wyden Wednesday, shows in some cases only a few hundred people with tens of millions in their IRAs, the data does not show the probably millions of people that lost money on their speculative IRA investments. Of course there will always be those that have better returns on their IRA investments, but that is true for all investments. Are we going to limit what people can earn on their investments? That’s ridiculous. Then what’s the point of risking capital to grow businesses?

A Valid Point

Next, the issue of some people having access to restricted venture capital startup-type stock that can be valued at near zero may be a valid concern. But again, these people are taking risks and most of these do not turn into multimillion-dollar tax-deferred investment returns. Most actually lose money, but we don’t hear about those, just like we don’t hear about the millions of people who don’t win the lottery. We only hear about the big lottery winners. But maybe the difference with the lottery is that everyone can play.

So the senators might have a point in limiting this kind of stock from being sheltered in retirement accounts. If anything, most people should have more stable investments in a retirement account since those funds will need to be relied on for many years in retirement.

Uncle Sam Loves IRAs

In addition, the JCT report lists more people with mega-millions in traditional IRAs than Roth IRAs. The government should love this! Accountants like me would call this a healthy balance of accounts receivable — large amounts of future income tax that the government will reap.

This is why I said above that this is, in fact, a growing benefit for Uncle Sam. Accounts receivable are assets on the balance sheet, which means they are liabilities for those who owe it. These funds are growing only tax-deferred. The tax day of reckoning still looms over them. The only way to use these funds is to withdraw them and that will trigger an income tax bill. The tax deferral cannot go on forever. Traditional IRAs are subject to required minimum distributions which will have to begin after age 72.

But there’s even more future benefit to the government — additional growing accounts receivable. All IRAs, both traditional and Roth, are included in the estate. Even these large IRAs will be heavily cut down (more like eviscerated) by substantial estate taxes. In some cases, this can be a double tax hit if there are state estate taxes as well. Anything left after that tax carnage that goes to beneficiaries must generally be distributed within a decade after death and that will end these accounts, or whatever is left of them after the tax man collects the big receivable.

The bottom line is that these large IRAs are not as valuable as they appear once taxes are figured in. Taxes on these mega-balances are pure debt, and that debt grows for the government’s benefit every time these balances increase. Remember that IRAs do not receive a step-up in basis like most other appreciated property. Every dime will be taxed and maybe double taxed (estate and income tax).

This is big “nothing-burger” story. The senators have a solution here looking for a problem.

Statements looking to tamp down on retirement account advantages will just open the gates to more people avoiding them due to uncertainty about tax rules being changed when they reach their retirement years.

What Congress Should Do

Congress should be encouraging retirement savings rather than looking to create restrictive policy aimed at the few grains of sand with these mega-IRAs compared to the tens of millions of IRA owners who are counting on these funds for retirement.

What Congress should be doing is making it easier for more people to save for retirement, for example by eliminating the useless income limits on Roth contributions. Congress wants to encourage Roth IRAs anyway since they like the current revenue they bring in when deductions are eliminated. Unlike financial and tax advisors, Congress only looks at results that fit their budget cycles. Lucky for all of us, they are the world’s worst financial planners. They only think short term.

And they should get rid of lifetime RMDs for traditional IRAs. The funds will have to be withdrawn by the end of the 10 years after death anyway, leaving more taxes to be collected by IRS. At this point RMDs are just a pure annoyance for seniors.

They should be free to withdraw as they please, like they can do with Roth IRAs. Again, anything they don’t withdraw is just a growing accounts receivable for Uncle Sam. Too bad Congress does not see this, and instead looks for these “shocking” headlines. Some accountant should show them a balance sheet and explain what accounts receivable are.

Much ado about nothing.

Ed Slott, CPA, is president of Ed Slott & Co.