Updated Thursday, July 24, 2014 as of 9:05 AM ET
Blogs - Rethinking Retirement
Required Minimum Distributions for Roth IRAs?
Wednesday, March 5, 2014
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President Obama’s 2015 budget includes a number of proposed changes aimed at retirement accounts. Six out of the seven provisions (or similar versions of them) detailed below and unveiled Monday, were included in last year’s budget.

If you’re hoping that some or all of these proposals will actually become law, it’s probably not a good idea to hold your breath.

The fact that all of the major retirement account-related proposals from last year are repeated in this year’s budget should tell you something – none of them were enacted from last year’s budget. They all require at least some level of Congressional action to implement, so the Vegas odds are probably not too high on getting much more implemented this year.

Nevertheless, it’s important to know the key retirement account provisions included in the President’s budget this year, because they certainly could happen and, at the very least, they are an indication as to where the administration wants to head. Here are the key changes you should know about:

‘HARMONIZE’ ROTH IRA RMD RULES WITH OTHER RETIREMENT ACCOUNTS

This is the only new one on the list this year and when people catch on to it, it’s bound to make some major waves. Under the premise of simplifying the tax rules for retirement accounts, President Obama’s 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. Not only that, this proposal gives all those who haven’t made Roth conversions over the years because they “don’t trust the government to keep their word” more ammunition.

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, such as for disabled beneficiaries and a child who has not yet reached the age of majority.

While this proposal might simplify the required minimum distribution (RMD) rules for most beneficiaries, it would mark the death of the “stretch IRA.” 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.

RETIREMENT SAVINGS ‘CAP’ 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.

RMD ELIMINATION IF RETIREMENT ACCOUNTS TOTAL $100,000 OR LESS

(8) Comments
Consider this all Caps? I will want to AMEND ALL my personal tax returns since 2009! I can't read any more of the above past the second paragraph (yet)!
Posted by Bruce B | Wednesday, March 05 2014 at 4:21PM ET
Add your comments here.
Posted by Fred J | Wednesday, March 05 2014 at 5:21PM ET
I thought more about the topic and believe if Congress really approved this they would also likely Grandfather Existing Roth's to not require RMDs. (I also realize tax returns have a statute of limitations for amending.) I have paid a high price for the Roth IRA's I have in place. Back to the topic - thanks Jeffrey!
Posted by Bruce B | Wednesday, March 05 2014 at 7:21PM ET
I continue to be amazed by this President's lack of understanding and downright stupidity. It further enforces my belief that no one should be allowed to run for President without actually having held a real private-sector job as a qualification!!!!

GWS

Posted by Glenn S | Thursday, March 06 2014 at 11:07AM ET
Some of those proposals make us, the financial planners, look really bad. Can you imagine at our suggestions our clients pay the tax & convert to Roth, only to find out later the rule changed again? The lawsuit, lots of them, are waiting to happen. Whose fault is it?

In addition, practically speaking how are you doing to tax the 401k w/d again in the future? If you pay 28% tax on it now, when you w/d, do you have to pay the tax again? Yes, one can argue maybe a separation at the account set up. However, can you imagine once again the paperwork required & new software updates to this change?

Why can't the President just leave people's retirement account alone? If he truly stands for the low-income class people, he can ask his Hollywood friends to start to adopt poor families. They all own huge mansions & servants. Wouldn't that be a new change?

Posted by rose s | Thursday, March 06 2014 at 12:42PM ET
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