The Government Wants To Limit Your Retirement Savings!

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.
 

federal-budget


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?

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24 Responses to The Government Wants To Limit Your Retirement Savings!

  1. Honestly, this doesn’t bother me as much as it probably bothers others. The reason being is that if you hit that $3m mark, it’s not like you can’t save for retirement, you just have to do it in a different account and/or investment type. Are there tax implications? Probably, but I guess I look at it that those affected will likely have people advising that that will minimize or eliminate the tax implications, so in the end, it probably will a blip on the radar, if even that.

    • This is where I ended up on the issue too. I was a whole lot more upset about it before sitting down and really thinking about it. It does make me uneasy that they could expand something like this down the road, but I don’t think going after the middle class will ever be a popular political move.

  2. I agree that this sets a bad precedent and isn’t spelled out clearly enough.
    1 – would the amount be indexed to inflation? An annuity that pays out $200K isn’t going to feel nearly as extravagant in 30-40 years as it does today.
    2 – how can they ensure there’s no marriage penalty? Married people are already penalized when it comes to income caps on putting money into IRAs and Roth IRAs, if they start capping combined marital assets as well, it just makes it that much more ridiculous for married people.

    • I would hope it would be indexed to inflation or else it makes no sense at all!

      Married people do get a raw deal from the government. I guess its all the more reason to stay single as long as possible :)

    • Chris says:

      I don’t see how married people get a raw deal unless their income is very large. According to the IRS (http://www.irs.gov/uac/2013-Pension-Plan-Limitations), the only limitations I can find are $17,000 (or $23,000 if over 50) per person unless $178k-$183k. The phase-outs appear to be more on IRA contributions.

      Please enlighten me if I missed something that doesn’t allow couples to put aside a substantial amount of money into retirement savings accounts. :-)

  3. I love the irony of everyone needs to save more for retirement, but not too much. This won’t affect me much. I don’t care for the idea of locking my money away for 30 years. I would rather keep the bulk of my savings in taxable accounts so that I can hit financial independence as soon as possible.

    • Most Americans are so far behind in saving for retirement that they need every incentive they can get to make them save more. Something like this affects so few people, but I think just the talk of it could discourage people from saving what they need.

    • Chris says:

      That’s the direction I’m heading too as well. Especially while our tax rate is so low.

  4. krantcents says:

    I think it is pretty unusual for any individual to accumulate $3 million in their IRA. I don’t think this limit will stop anyone because it is a number beyond most people’s imagination. The limit will make the people who are in that situation transfer money to a Roth IRA. This is one of the reasons I have a brokerage account.

    • The limit is supposedly across all of your tax advantaged accounts. So I don’t know that a roth transfer would help. I think if you have more than $3 mil you’d be relegated to a traditional brokerage account after that.

  5. I doubt this will affect me but still not happy about the idea that the government is trying to place limits on what people can and cannot do with their money. If they want to save money then cap the amount you can have written off as deductions for people who make over a certain amount.

    • If they phrased it as eliminating the tax benefits for anything over $3 mil rather than saying $3 mil is the max you can save everyone is probably having an entirely different discussion right now.

  6. Brian says:

    People forget that IRAs (ROTH has only been around since like 1997) and 401ks haven’t really been around all that long and that people (like our grandparents) saved money in taxable accounts. This is what the rich would continue to do.

    • That is what they’ll do. But it’s a little unnerving to offer tax advantaged accounts to everyone and then one day decide certain people are no longer eligible.

  7. The cap wouldn’t change my retirement savings at all. Currently I’m only contributing enough to get the employer match to my 401k and the rest I’m saving in my taxable account. I really don’t want to lock up my savings until I reach 59.5 so I’m doing enough to get the benefit but nothing more.

    Is the $3 mill across all accounts or per account? Because that really would be a nightmare to administer if it’s total savings. There’s way to many special cases to even try and do this.

    I am worried though about the possible loss of tax deduction for 401k contributions or the Roth no-tax status. Nothing would surprise me from our government including them confiscating all the 401k contributions for them to manage. I’ll stick with the majority of my savings being in taxable accounts because I think that would be the last one that would have any serious changes made to it.

    • As I understand it the $3 mil is across all your tax advantaged accounts.

      This itself doesn’t bother me as much as what it could lead to. The idea of the gov’t further restricting the tax benefits we receive from our retirement accounts isn’t something I want to deal with.

  8. Same over here it seems. There is £1.5 million total limit and the annual limit that can be put into a SIPP retirement fund has been reduced from £50k to £40k.

  9. Tom Whiting says:

    That’s a 3 million dollar limit this year…. next year it drops to 1 million, then 250,000, and finally zero by 2020!
    Don’t laugh…. that’s exactly what would happen, and YOU know it!!
    Government…. leave my fricking Retirement funds alone.
    In fact, just get completely out of my LIFE!
    Obama shows us that we’d be better off with NO president… why don’t we try that for 4 years???
    TAW

  10. I’m all for this policy! It’s ridiculous these tax-dodging multi-millionaires can escape paying their fair share with these gimmicks. Ridiculous!

    • Chris says:

      Have you given thought to your statement, using the knowledge of the AMT which was hitting more and more middle-class folks.
      Remember, a fool and his money are soon parted. :-(

  11. It’s a brave new world out there after Cyprus. Like you, I’m of two minds about this. If you can’t retire on 3 million dollars, you have a serious problem. But the second you make a single exception to a cardinal rule of saving, people can’t reasonably expect any of their money to be safe.

  12. Love your thoughts here, and agree with them too, about capping the tax savngs at 3mil and then letting people save their other money without the tax benefit. Like so many others said, we definitely don’t want to set a precedent for letting the govt. control anybody’s money on too strict a level. Then it isn’t OUR money anymore.

  13. Pingback: My inspiration in last week #17 | Hello Suckers ...

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