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Financial Planning > Tax Planning > Tax Reform

Debate: Should Multimillion-Dollar 401(k)s, IRAs Be Reported to the IRS?

By Robert Bloink By William H. Byrnes

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Lawmakers in Congress have weighed various proposals in recent months to ensure that the top-income taxpayers in the U.S. pay their fair share of income tax. Some of those proposals have targeted Roth-style retirement accounts, which can be used by ultra-wealthy taxpayers to grow investments and withdraw their earnings without paying any taxes at all.

One proposal would require retirement plan custodians to report any account balances in excess of a certain threshold (some proposals set the threshold at $2.5 million; others have proposed higher limits).

We asked two professors and authors of ALM’s Tax Facts with opposing political viewpoints to share their opinions on imposing reporting obligations on retirement accounts with large balances.

Below is a summary of the debate that ensued between the two professors.

Their Votes:

thumbs up Bloink
Thumbs down Byrnes

Their Reasons:

Bloink: Realistically, the IRS doesn’t currently have the data it needs to have to restrict the tax benefits of retirement savings vehicles of ordinary hardworking Americans. Too many millionaires are able to leverage the currently existing rules to build multimillion-dollar retirement nest eggs without paying any taxes at all.

While we want to engage in tax reform strategies designed to ensure that the wealthiest Americans pay their fair share of taxes, we don’t always have the information about where these taxpayers are stashing their investment earnings if those earnings are contained in Roth IRAs.

Byrnes: This proposal would create yet another administrative headache for plan sponsors who are already struggling with ever-changing rules and administrative challenges. The ordinary Americans that we would ultimately be trying to help with a reporting rule such as this would actually suffer as a result — because in the end, many employers could decide that offering a 401(k)-type option isn’t worth the trouble.

Bloink: Even if we manage to close all the tax loopholes that the super-rich currently use to maximize pretax retirement savings, we still need a way to limit these tax-preferred accounts so that they aren’t used to allow the ultra-wealthy to avoid paying any income taxes at all. This reporting proposal would give the IRS the tools to enforce any limitations that Congress is able to enact.

Byrnes: If this proposal actually became law, the ultra-wealthy would simply move onto a new investment strategy while millions of low- to middle-income families could lose a valuable tax-preferred savings tool. In other words, it is very likely that a reporting rule like this would actually backfire.

Bloink: Retirement accounts are given tax preferences to encourage ordinary Americans to save to fund their own retirement. They are not meant as tax shelters for the ultra-wealthy. As we’ve seen in recent years, the very rich are often able to use their Roth investments to amass fortunes within these tax-preferred accounts. Those earnings are then withdrawn tax-free under the law.

That is not what these retirement accounts are designed to do. More detailed reporting requirements would give the government a clear picture of how these accounts are being used so that we can impose valuable limitations to ensure everyone pays their fair share.

Byrnes: Very few Americans are using Roth IRAs as tax shelters. Those that have managed to amass large investment gains within Roth accounts have often done so after using their retirement funds to invest in risky startup businesses that happened to make good.

We don’t want to discourage that type of investment — and we shouldn’t be trying to punish Americans for using legitimate tax-preferred savings strategies in a legal way, remembering that Americans are free to choose their own investments within their retirement accounts.

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Robert Bloink

William H. Byrnes

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