In early February President Obama submitted his annual budget request to Congress. Congress will then consider the President’s requests when developing its own budget resolution. As he has done in years past, the President has included some provisions in his budget proposal that could significantly change some retirement strategies and financial plans. It is always important to know what is ‘on the radar’ in Washington, even if the likelihood of having these provisions being included in the next budget remains small. What follows is a summary of some of the President’s proposed changes that could impact retirement planning and estate planning significantly if they were enacted.
Required Minimum Distributions for Roth IRAs
The President’s budget proposal would synchronize the rules between Roth and traditional retirement accounts by requiring minimum distributions from Roth accounts upon reaching age 70 1/2. This proposed rule would also prevent additional contributions to Roth retirement accounts after age 70 1/2.
Note: While this proposal would not generate immediate tax revenue for the US Government from the withdrawals, there could be future tax revenue from capital gains, dividends and interest on the distributions once they are out of the Roth IRA accounts.
Elimination of Backdoor Roth IRA Contributions
The backdoor Roth IRA contribution strategy first emerged in 2010 when income limits on Roth IRA conversions were removed. The President’s proposal would limit a Roth conversion to the pre-tax portion of an IRA only; after-tax contributions to a traditional IRA would no longer be eligible for conversions.
This proposal would generate additional tax revenue for the government as the only Roth conversions permitted would be for pre-tax traditional IRA assets which are taxed at the time of conversion.
Elimination of Stretch IRA Rules for Non-Spouse Beneficiaries
This proposal would force non-spouse beneficiaries to withdraw the money from inherited IRAs over a five-year time period, instead of over the beneficiary’s lifetime as is currently permitted. This proposal would accelerate the tax revenue on the IRA distributions into a five year-time period.
While this proposal eliminates some planning options for IRA beneficiaries, the proposal also potentially shortchanges the amount of tax revenue that the government would earn on lifetime IRA distributions, especially from young beneficiaries.
Limiting New Contributions for Retirement Accounts Reaching $3.4 Million
President Obama has proposed this before, beginning in 2014. Under the proposed provisions, once the total account balance across all retirement accounts reaches $3.4 million or higher, no new contributions would be permitted.
The proposed rule does not force existing dollars out of any retirement accounts once the $3.4 million threshold has been reached, nor does it force distributions if assets in the retirement accounts appreciate beyond the $3.4 million mark.
Elimination of the Step-Up Basis Rule
There have been some significant changes that have occurred concerning estate planning in recent years, most significantly with the estate exemption amount before the Federal estate tax is applied. The President’s new budget proposal could change the way property is transferred at death, issuing a new era in estate planning.
Rather than dealing with carryover cost basis or step-up in basis, the budget proposal taxes all capital gains at death, much the same way as if the decedent had liquidated all possessions at death. Capital gains would be reported on the decedent’s final income tax return, and gains could be offset by capital losses that occurred in that year and any applicable loss carry forwards. The budget proposes an exclusion for the first $100,000 of capital gains and a $250,000 exclusion for any residence.
Assets passed to a surviving spouse would still retain a carryover in basis, and any unused capital gains exclusion would be portable and carry over meaning that a married couple would have an exclusion of the first $200,000 of capital gains and $500,000 for any residences.
The President’s budget proposal isn’t all bad news. There are some favorable provisions in the budget proposal including:
- Eliminating Required Minimum Distributions for those with less than $100,000 in retirement accounts.
- Expanding the exceptions to early withdrawal penalties for IRAs to include living expenses for long-term unemployed individuals.
- Marriage penalty tax relief with an up-to-$500 two-earner tax credit.
- Expansion of automatic enrollment of IRAs and multi-employer small business retirement plans.
As stated earlier, it isn’t likely that many (if any) of these provisions in the President’s budget proposal will be implemented in 2016. As discussions for tax reform turn to 2017 and beyond, however, it is likely that that some of these talking points will be revisited so it is important to be aware of what financial planning changes are possible down the road.