An old adage says the only two certainties in life are death and taxes. President Barack Obama is proposing a new twist: accelerated taxes on retirement savings AFTER death.
Obama wants to change the way the government taxes 401(k) retirement plans and individual retirement accounts belonging to ordinary Americans and the rich alike when they pass to certain heirs.
The popular 401(k) plans and IRAs offer tax-deferred savings for retirement. Financial assets in these plans grow in value over time but are taxed only when account holders retire and begin taking money out.
The proposed changes wouldn’t affect spouses who inherit the retirement plans. They target other beneficiaries – children, siblings or partners of the deceased – by forcing them to take the money out of the inherited account within five years. That brings the government more tax money up front.
It also requires heirs to take the money in larger chunks, which in some cases could bump them into higher tax brackets.
“The only exceptions would be disabled or chronically ill individuals, someone who is not more than 10 years younger than the participant or an IRA owner or a child who has not reached” legal adulthood, said an analysis by the website Benefitspro.
Heirs falling under those exceptions could still take the inherited money out of the accounts over the course of their lives. Presently, a non-spousal heir receiving $200,000 in a retirement account can take it all at once and pay taxes on it, draw down $10,000 a year for 20 years or do so under any time frame of their choosing.
If the Obama proposal becomes law, that $200,000 would have to be disbursed within five years, and not only is tax revenue pulled back more quickly but heirs also have fewer choices in how to take money that might affect their own tax statuses.
For example, a single taxpayer pays 10 percent on taxable income up to $9,225, 15 percent on the income up to $37,450, 25 percent on income up to $90,750, 28 percent on income up to $189,300, and 33 percent up to $411,500.
A Treasury Department official, speaking only on the condition of anonymity as a matter of policy, said the goal was to bring these plans “more in line with the intent of the tax preference for retirement savings.”
Tax wonks agree.
“The point . . . is to save for retirement, not to provide a windfall tax savings to your heirs,” said Leonard Burman, director of the Tax Policy Center, jointly run by the center-left Brookings Institution and the centrist Urban Institute. “The biggest benefit under the current policy is for geezers who marry trophy wives and have young kids . . . who’d be getting tax-deferred benefits for 30 or 40 years.”
That’s certainly the case now, but as more Americans born from 1946 to 1964 hit retirement age, these baby boomers are more likely than past generations to have more in tax-deferred retirement accounts that might outlast them and pass to heirs. The 401(k)s and IRAs took off in the late 1980s and have since replaced traditional pension plans.
Obama’s proposal also would be a windfall for government coffers. It would raise a projected $5.4 billion over 10 years, according to his budget plan.
The administration provides few details, if any, on how it came up with that number.
There are plenty of statistics on how many people have 401(k) plans and their average balances. But there’s almost nothing about the average balance in a 401(k) plan or IRA when someone dies, or even how many account holders have died and who inherited the sums remaining in their plans.
“I can virtually guarantee that nobody has any real statistics on that,” said Jack VanDerhei, director of research for the Employee Benefit Research Institute, which compiles retirement-savings data.
His institute is trying to gather such information.
What little published data exists comes from the Internal Revenue Service. It compiles charts on the taxation of estates worth more than $5 million, and it has a category for retirement assets. But it doesn’t publish any data on retirement assets for estates valued below that amount and not subject to the estate tax.
The latest IRS number, for the 2011 tax year, showed there were only about 5,900 estates valued above $5 million, and among them these deceased left a combined $7 million in retirement assets. That averages $1,186 per estate, hardly suggesting that the uber-wealthy are stuffing money into retirement accounts to pass to heirs.
A McClatchy review of available data shows that at the end of 2013, there were 26.4 million 401(k) accounts, with an average balance of $72,383. The Employee Benefit Research Institute’s database follows a sample group of about 4.2 million of them over time.
About 20 percent of those sample accounts contained financial assets that totaled more than $100,000, and about 10 percent of the accounts in the sample had balances above $200,000. By contrast, about 39 percent of the 401(k) plans in the institute’s sample database have balances below $10,000.
These numbers suggest the obvious about who might get hit by the Obama plan. Those with low balances, “this is not going to be an issue for them,” said VanDerhei. “Upper incomes certainly have this as an option” and might be affected.
This might explain why Obama included the 401(k) change with broader proposals to limit tax-deferred savings for the wealthy.
“We are basically incentivizing people that rather than putting that money to work in the economy (they) hold it in illiquid assets, often for multiple generations in a way that just doesn’t make a lot of sense,” Shaun Donovan, the director of the White House Office of Management and Budget, told McClatchy recently, decrying “fundamental unfairness” in the tax code.