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Wealth & Well-Being

Fiscal 2015 Budget Affects Roth IRA Planning

Deep within President Obama's Fiscal Year 2015 Budget, are a number of proposed changes aimed at retirement accounts.  Six out of the 7 provisions below were included in the 2014 fiscal budget, but weren't enacted.  The fact that all of the major retirement account-related proposals from last year are repeated in this year's budget indicates that they could have difficulty passing this year as well.  However, we think it's important to know what's on the table when considering your tax planning strategies.

"Harmonize" the RMD Rules for Roth IRAs with Other Retirement Accounts

President Obama's Fiscal Year 2015 Budget calls for a provision that would require Roth IRAs to follow the same required minimum distribution (RMD) rules as other retirement accounts. In other words, you would have to begin taking RMDs from your Roth IRA when you turn 70 ½, the same way you do with your traditional IRA and other retirement accounts. If this were to come to pass, it would be a MAJOR game-changer when it comes to retirement planning.

The fact that Roth IRAs have no RMDs is one of the key reasons many people decide to contribute or convert to Roth IRAs in the first place. If this proposal were to become law, conversions would make sense for far fewer people.

Create a 28% Maximum Benefit for Retirement Account Contributions

The maximum tax benefit (deduction) for making contributions to defined contribution retirement plans, such as IRAs and 401(k)s, would be limited to 28%. As a result, certain high-income taxpayers making contributions to retirement accounts would not receive a full tax deduction for amounts contributed or deferred.

Example: Currently, if an individual with $500,000 of taxable income defers $10,000 into a 401(k), they will not pay any federal income tax on that $10,000. Without that salary deferral, that income would be taxed at 39.6% (currently the highest federal income tax rate). However, if this proposal were to become effective, that $10,000 would effectively be taxed at 11.6% (39.6%-28% = 11.6%), since the maximum tax benefit that a client could receive would be limited to 28%. That equates to an additional tax bill of more than $1,000.

Mandatory 5-Year Rule for Non-Spouse Beneficiaries

Most IRA (and other retirement plan) non-spouse beneficiaries would be required to empty inherited retirement accounts by the end of the fifth year after the year of the IRA owner's death (known as the 5-year-rule). The proposal does call for certain exceptions to this rule, but they are minimal.

While this proposal might simplify the required minimum distribution (RMD) rules for most beneficiaries, it would end the ability to stretch your IRA over time.  Most non-spouse beneficiaries would face more severe tax consequences upon inheriting retirement accounts and as such, the value of these accounts as potential estate planning vehicles would be diminished.

Establish a "Cap" on Retirement Savings Prohibiting Additional Contributions

New contributions to tax-favored retirement accounts, such as IRAs and 401(k)s, would be prohibited once you've exceeded an established "cap." This cap would be determined by calculating the lump-sum payment that would be required to produce a joint and 100% survivor annuity of $210,000 starting when your turn 62. At the present time, this formula produces a cap of $3.2 million. If you ended up with more than this total in cumulative retirement accounts at the end of a year, you would be prohibited from contributing new dollars to any retirement accounts in the following year. The cap would be increased for inflation.

Eliminate RMDs if Your Cumulative Retirement Account Savings is $100,000 or Less

If you have $100,000 or less - across all of your retirement plans combined - you would be exempt from required minimum distributions. Failing to take the proper RMD amount comes with one of the stiffest retirement account penalties there is - a 50% penalty on any shortfall. This proposal would eliminate that possibility if you have $100,000 or less in retirement accounts and would allow you to take as much (or as little) as you want without a penalty.

Allow Non-Spouse Beneficiaries to Make 60-Day Rollovers of Inherited Assets

Non-spouse beneficiaries would be allowed to move inherited retirement savings from one inherited retirement account to another inherited retirement account via a 60-day rollover (in a manner similar to which they can currently move their own retirement savings).

Unifying the rollover rules for retirement account owners and beneficiaries would greatly simplify this aspect of retirement accounts and reduce the number of costly mistakes that are often made by beneficiaries under the current rules.

Mandatory Auto-Enrollment IRAs for Certain Small Businesses

Employers in business for at least two years that have more than 10 employees and don't offer another retirement plan already would be required to offer auto-enrollment IRAs to their employees. Contributions to employees' IRAs would be made on a payroll-deduction basis. Employees would be able to elect how much of their salary they wish to contribute to their IRA (up to the annual IRA contribution limit), including opting out entirely. In the absence of any election, 3% of an employee's salary would be contributed to their IRA. Employees would be able to choose whether to contribute to an IRA or Roth IRA, with the Roth being the default option. The provision would also enhance incentives, in the form of a tax credit for small businesses, to adopt a company-sponsored retirement plan.

Our Fiscal Budget Process

The 2015 United States Fiscal Budget period runs from October 1, 2014 through September 30, 2015.  The budget resolution must be agreed upon by both the House of Representatives and the Senate in order to become final.  In recent years, Congress has not passed all of the appropriations bills before the start of the fiscal year. Congress may then provide for the temporary funding of government operations. Failure to appropriate funds results in a partial government shutdown, such as in October of 2013, so we have a long way to go if the above proposals are to pass.  As of this writing it appears that Congress will pass a continuing resolution to extend current funding levels and carry on discussions about these changes.

We at Northstar are watching these tax provisions closely and will be keeping our clients informed of further developments.  If you have questions or would like more information please contact me at 603.458.2776 or by e-mail at kristina@northstarfp.com.

Written by Kristina George, CPA, CFP, CDFA

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