It’s February, and that means that it’s time for the President’s budget proposal. The 2017 proposal will be Obama’s last. Congress will consider this proposal and then come up with their own budget resolution. These proposals will often include potential tax law changes; this year is no different. Want to know how it could impact you? I’ve got you covered.
ESTABLISHING REQUIRED MINIMUM DISTRIBUTIONS FOR ROTH IRAS
One of the biggest advantages of a Roth IRA is that it accumulates tax deferred AND has no required minimum distributions (RMD). Traditional IRAs have always had RMD requirements. An RMD is the government’s way of saying “we want our money.” It works like this; once you reach age 70 ½, you are required to start taking distributions on your IRA (or 401(k), 403(b), or other qualified plan). These distributions are taxed at your ordinary income rates. You must take these distributions whether you need the money or not. The amount required is based on your account value at the previous year’s end and your life expectancy as determined by IRS tables. The new proposal would impose these RMDs on Roth IRAs for the first time. What does this mean for you? You may have planned on letting your Roth IRA grow to gift to your heirs because of the ideal tax-deferral, but now you may need to start withdrawing money. Unlike a Traditional IRA, these distributions will be tax-free. However, this could throw a wrench in your plans to leave a sizable bequest. This could also deter investors from utilizing Roth IRAs in the future.
ELIMINATING STRETCH IRA RULES
Right now, you have two options when you inherit (non-spousal) IRA assets: You can take distributions out penalty-free over five years (The 5 Year Rule) OR you “stretch” the distributions out over YOUR life expectancy. This “Stretch Rule” can allow you to hold this account for the rest of your life, making it a substantial part of your retirement savings. The President’s budget proposal could kill the Stretch IRA rule. This would mean that you can no longer allow your inherited IRA to accumulate tax-deferred over a long time horizon. Instead, you must use the 5 Year Rule which forces you to deplete the account over 5 years, insuring that the government will receive their tax revenue earlier, rather than later.
ELIMINATION OF STEP-UP IN BASIS, TO BE REPLACED BY A REQUIRED-SALE-AT-DEATH RULE
This is something that can affect anyone that inherits any brokerage accounts or property. As of now, when someone inherits property or non-retirement (IRA, 401k, etc) accounts, they receive a “step-up in basis.” This means that any capital gains, or the difference in the purchase cost of the investment and the current market value, are not taxed. The inheritor “steps-up” the basis to the current market value at the date of the decedent’s passing. The President’s budget proposal would eliminate this. It would require that the inherited assets be treated as sold at the time of the decedent’s death and all taxes be assessed on the decedent’s final tax return. This could drastically reduce the value of your inheritance. There will be a $100,000 exclusion on assets and $250,000 on residences, but many investors are above these thresholds. If you have assets over that amount, your bequest will likely be reduced anywhere from 15-23.8%!
Other proposed changes that could negatively impact investors:
- Elimination of specific-lot identification for securities- this essentially gives you less flexibility when selling assets, making tax-management of your assets tougher.
- Wealthy investors can no longer contribute to retirement accounts? If your retirement accounts combine to total $3.4 million, you may no longer make contributions. Why would we ever discourage anyone from saving more via tax-deferral?
- Elimination of back-door Roth IRA contributions- Not everyone is eligible to make Roth IRA contributions. If your income deems you ineligible, there is another way. The back-door contribution involves making non-tax deductible contributions and later converting them into Roth status. This would be eliminated under the latest proposal.
We have a retirement savings crisis in America. Why would we make things more difficult to accumulate and preserve wealth? It makes no sense to me. Shouldn’t we instead promote and encourage saving so that we can retire self-sufficiently? The government hasn’t shown the ability to spend wisely, so I’m not optimistic that making changes that can negatively impact individual investors to get money into government’s hands will make anyone better off. Do you?