This week President Obama released an overview of the proposed 2013 federal budget. Most political pundits do not believe Congress will come to an agreement on a joint budget resolution this year because it is an election year and the proposal includes a number of budget cuts and raises taxes on higher-income Americans. Still, it provides a blueprint of what President Obama's proposed budget would look like if he is re-elected.
While the bigger picture budget items garner most of the media's attention, there are other areas of the legislative process that agents may want to monitor.
Among them, the Senate Finance Committee is expected to pass a highway bill that boosts revenues with a series of narrow tax increases, including raising taxes on money saved for retirement.
The Senate committee is focusing on 401(k)s and stretch IRAs. Under current law, owners of IRAs can stretch the life and increase the value of tax-deferred IRAs by passing them along to children or grandchildren at death. That’s because required annual minimum distributions are typically calculated using life expectancy tables. Younger people get smaller payouts, so when they inherit an IRA, the money lasts longer and often grows more.
While the House version of the transportation bill doesn't contain the IRA tax change, the proposal provides a warning that Senate leaders are likely to continue targeting personal retirement accounts.
The Senate bill would require taxes to be paid on the account as if it were fully distributed within five years of the account holder’s death. There would be hardship exceptions for certain beneficiaries, including children with special needs.
The proposal would raise about $4.6 billion over the next decade. The issue for some older affluent Americans is that, based on the advice of their advisors, they converted their regular IRAs to Roth IRAs and chose to pay current income taxes. That way, upon their death, they could pass their IRAs to their children, who could take advantage of the tax-free income over their lifetimes.
While there is nothing certain in death and taxes and some people may believe the current tax rules are too generous, the matter highlights the political risk in making decisions about the most efficient way to save for retirement and build an estate to pass on to the next generation.
Some people may wonder what other future changes could be made to Roth IRAs if budget deficits drive additional changes. Would there ever be a maximum amount that people can accumulate tax-free in a Roth? Would that change the rules to have Roth IRA distributions included for purposes of determining whether and to what extent Social Security benefits are taxable?
No doubt the next couple of years and the outcome of federal elections will impact many aspects of the tax code. Independent agents should be sure to monitor the outcome and let their clients know of the potential changes.
Dave Evans (
dave.evans@iiaba.net)
is a certified financial planner and an IA l-h contributing editor.