The US government wants to limit how much money you can save across your tax-advantaged retirement accounts (401k,IRA, Roth IRA…).
President Obama released his budget plan the other day and one specific proposal really caught my attention. In the name of raising $9 billion in new revenue for the government, the President wants to limit the amount you can save in your retirement accounts to $3 million.
The reasoning for the $3,000,000 limit is that it’s about equal to an annuity that would pay out $205,000 per year. A “reasonable retirement” in their terms.
My initial reaction to the plan was some combination of shock and anger. “How dare they tell us how much we can save in our retirement accounts!” However, after taking the time to sit down and think about it some more, I can see both side of the argument.
Not many people are affected, at all. Currently 0.3% of all IRA’s and 0.11% of all 401k’s would be affected by the change. Given that the average retirement savings of people approaching retirement is less than $200,000 it’s unlikely that many more will be affected down the road.
Just in case you think you’re special, with a 7% return a 25-year-old starting to save for retirement today would need to max out both their 401(k) and Roth IRA ($23,000/yr at current limits) for the next 35 years. Possible, but highly unlikely.
I also get that rich people use tax advantaged accounts to avoid taxes. During the 2012 presidential campaign Mitt Romney said that he had somewhere between 18 and 84 million dollars saved in his IRA. I also get that the tax benefits on these accounts were designed to encourage lower and middle class people to save more, not to help the rich avoid taxes. You won’t find me shedding any tears because a rich guy has to pay a bit more in taxes, but reducing the average person’s incentive to save for retirement is not a smart way to accomplish that goal.
However, what worries me is the precedent that this sets. It’s basically saying that retirement accounts are fair game. It says that at some point down the road the government can just decide that distributions and earnings taken from a Roth IRA are no longer exempt from taxes. Or that your 401k contributions are no longer tax deferred. We all assume these benefits are a sort of sacred cow that will be with us for our lifetimes, but this should be a wake up call for us to not take anything for granted.
Another worry is that this will discourage people from contributing as much as they should in these accounts in the first place. The average American isn’t going to do the math and realize how hard accumulating $3,000,000 is. The average American is going to hear that your 401k and IRA balances are capped and think…why bother?
The good news is that there is little to no chance that this budget passes. Not only because of the attention that this particular proposal is generating, but because this congress would (and has) shoot down its own ideas as soon as the President agrees to them. Don’t lose any sleep worrying that anything will get passed “as is” by this government.
Even if this were to pass, it would be extremely difficult to implement. Many people have multiple 401k’s and IRA’s. The monitoring of balances would be a huge administrative task to begin with. Then add in the fact that balances are constantly fluctuating and it becomes a downright mess.
Say I have just over $3 million in my accounts right now. By this law I wouldn’t be able to contribute any more to my retirement accounts. Now say the market drops 5% over the next 2 months. I can contribute to my accounts again? If I contribute after that drop and the markets then take off and send my balances over $3 million again, what happens? Do I get penalized for contributing? It just becomes a confusing mess.
There also aren’t many details on how the retirement cap would be implemented. Would there be a higher cap for married couples? Would the cap be indexed to increase with the inflation rate? Would there be any exceptions?
A better way to accomplish this goal is to simply phase out the tax benefit at the set limit like happens already with the traditional IRA. Allowing people to contribute but phasing out the tax benefits after certain levels would accomplish the same goal but be received much more warmly than this current plan (in my humble opinion). Simply lowering the maximum yearly contributions or income limits would be another way to accomplish this goal while causing a little less of an uproar as most people don’t come close to maxing out their tax deferred accounts in the first place.
Even with the cap, people aren’t barred from saving. Chances are that if you were able to save up $3,000,000 in your retirement accounts you probably have a healthy amount of money saved in various taxable accounts. You’d still be able to contribute as much as you wanted to those.
The takeaways from this debate should be that nothing is sacred and that we all need to take long hard looks at our retirement savings strategies.
Hopefully the government will never decide to change the taxation rules on our 401k’s and IRA’s but we can’t assume that those tax benefits will last forever either. Just like how an employer cutting its 401k match isn’t necessarily a reason to stop contributing. The government changing the rules on retirement accounts shouldn’t be a reason to stop saving in them.
What should happen is that we take a look at our savings strategies and diversify how much and where we’re saving. Relying on just a 401k or a Roth IRA to get you through retirement could be just as misguided as someone who thought Social Security would be all they’d ever need.
We can only control what is in our power. Paying taxes is just a fact of life, and it shouldn’t be a deterrent to saving or making a profitable investment. If tomorrow morning the government decided that nobody got any tax breaks for retirement savings anymore. I would still save as much, if not more than I do today and you should too.
If you want to read the entire proposed budget for 2014 you can do so here.
What are your thoughts on the proposed cap? How would a $3,000,00 cap affect how you save for retirement?