2016 Budget Targets Retirement

1. Eliminate the Tax Arbitrage for Employer's Stock in an Employee's Qualified Plan

Under existing law, net unrealized appreciation (NUA) is a benefit when an employee hold appreciated stock of his employer in his retirement accounts. This modification would drop this favored tax treatment of employer stock in retirement plans. The changes would reinstitute the ordinary income tax rates paid on retirement distributions, as opposed to long-term capital gains rates. Under current law, to be eligible to use the provision, you must have appreciated stock of your employer (or former employer) inside your employer (or former)-sponsored retirement plan. There is a safe harbor: Any plan participant aged 50 or older by the end of this year (2015) would still be eligible for the special NUA tax treatment.

2. Limit Roth Conversions to Pre-Tax Dollars

After-tax money held in traditional IRAs or employer-sponsored retirement plans would no longer be eligible for conversion to a Roth account. Previously, taxpayers that have been restricted from making contributions directly to Roth IRAs (because their income exceeded their applicable threshold) have instead made contributions ' often non-deductible (after-tax) ' to traditional IRAs, then, shortly thereafter, converting those contributions to Roth IRAs. This two-step process would no longer be available.

3. Synchronize the Distribution Rules for Roth IRAs with the Rules for Other Retirement Accounts

The Administration seeks to impose required minimum distributions for Roth IRAs in the same way they are imposed for other retirement accounts. In other words, this proposal would require the taxpayer to take distributions from their Roth IRA once they turn age 70'; in the same way they would for their traditional IRA and other retirement accounts. If the taxpayer is 70' at the end of this year (2015), they would be exempt from the changes that would be created by this proposal. To change the rules now, after people have already made these decisions, would be inappropriate and not a large revenue generator. There is no equitable reason for changing the Roth distribution rules other than another attempt to move toward income redistribution.

4. Eliminate RMDs If Total Savings in Tax-Favored Retirement Accounts Is $100,000 or Less

It is proposed that if taxpayers' retirement accounts are under $100,000, then the distributions would be completely exempt from required minimum distribution (RMD) rules. Defined benefit pensions paid in some form of a life annuity would be excluded from this calculation. Under the proposal, the qualifying taxpayer would have no limitations or requirements of distribution.

5. Now You See It Now You Don't: 28% Maximum Tax Benefit for Contributions to Retirement Accounts

The maximum tax benefit (deduction or exclusion) is scheduled to a cap of 28%. A taxpayer in the 28% income tax bracket or lower would be unaffected by this provision. However, if the taxpayer is in a higher tax bracket, up to a 39.6% ordinary income tax bracket, the taxpayer would not receive a full tax deduction (exclusion) for amounts contributed or deferred into a retirement plan. According to the Greenbook , if a tax benefit for a contribution to a retirement plan was limited by this proposal, it would create basis in the retirement account. This course of action is to generate more tax receipts and creates a reporting nightmare full of complexities at a time when the Internal Revenue Service is unable to administer even the existing reporting rules. An additional headache is how this will integrate with local state tax regimes.

6. Establish a 'Cap' On Retirement Savings Prohibiting Additional Contributions

The administration is placing a ceiling over retirement funds that would prevent employer or employee funding when an arbitrary level is reached. This cap would be calculated by determining the lump-sum payment it would take to produce a joint and 100% survivor annuity of $210,000 per year, beginning when the taxpayer turns age 62. Currently, this would cap retirement savings at approximately $3.4 million. This is arbitrary and caprious as it is not tied into a region's different costs of living and is solely driven by the mantra of redistribution of wealth.

7. Providing the Long Term Unemployed Access to Retirement Funds Without Incurring a Penalty

This would exclude tax penalties on distributions from any form of retirement plan, including IRAs, whenever the taxpayer has been unemployed for 26 weeks or more, and has received unemployment compensation coverage at the local level. Furthermore, the distribution would have to occur in either the year the unemployment compensation was paid, or the following year. Finally, the exception would be limited to certain amounts. This does not relieve the participant from paying taxes on the distribution, but it does forego the penalty.

8. Mandatory Five-Year Rule For Non-Spouse Beneficiaries

The existing law permits beneficiaries of IRAs to extend the distributions from inherited IRAs over a substantial period of time ' by the end of the fifth year after the account owner's death. In contrast, today such beneficiaries are generally able to extend distributions from their inherited retirement accounts over their life expectancy. Distributions would be larger, putting beneficiaries into higher tax brackets and reducing their access to deductions, credits and other benefits that phase out in the higher brackets

9. Allow Non-Spouse Beneficiaries to Complete 60-Day Rollovers for Inherited IRAs

This tax proposal is a simple one. It brings parity to beneficiaries of inherited IRAs. Non-spouse beneficiaries would be allowed to move money from one inherited retirement account to another via a 60-day rollover, in a similar fashion to the way retirement account owners can move their own savings. There should be no objection to including such a provision in the tax code, as the budget consequences would be “negligible.” It would eliminate one of the most common, unintentional mistakes that affect IRAs.

10. Require Retirement Plans to Allow Participation from Long-Term Part-Time Workers

The budget expands coverage to for 401(k) plans so that a part time employee that has 500 hours of employment each year for a three (3) year period can make employee contributions into an employer's sponsored plan. The use of this approach is more expensive than the ability to put funds into an IRA either employer funded or employee funded.

Conclusion

There are other retirement-like modifications, such as with corporate owned life insurance (COLI). For contracts entered into or material modified by face amount or covered employees, there would be a limitation imposed on the interest deductions. This would also adversely affect the retirement and welfare benefits made available by employers. We continue this article next month with a discussion of 401(k) plans, ESOPS and more.

Lawrence L. Bell, JD, LTM, CLU, ChFC, CFP', AEP, has served as Tax Bar liaison to the IRS for 10 years. He has received patents in actuarial product fields dealing with COLI, GASB, FASB, IASB and OPEB solutions.

In February, the Obama Administration's Fiscal Year 2016 Budget (http://1.usa.gov/1CFdUKt'(150 pages)) was published, along with the Department of Treasury's Greenbook. The Greenbook (http://1.usa.gov/1vCZLZj (312 pages)) is a detailed explanation of the President's proposed budget. Because the proposed legislation must pass a Republican-led Congress, the President's budget may be “aspirational.” It is a good indicator of the tools the Administration is prepared to use to fund its wish list.

This year's version of the budget included a number of provisions targeting retirement plans. The Administration's attack on retirement savings have been a regular feature of budgets in recent years. It is of interest how many proposals were targeting retirement accounts, and how many new proposals there are. The budget featured over 15 provisions that, if they were to become law, could change the planning that has previously been permitted. The reference in the Greenbook to end Crummey powers in irrevocable life insurance trust is entirely consistent with the money grab. See Greenbook , p. 204. Additionally, if you consider proposed changes in President Obama's State of the Union address to tax the appreciated assets in a decedent's estate in addition to estate and inheritance tax, the Administration supports a confiscatory orientation to taxation.

Though all of these provisions will most likely not become law, once in writing they often get dusted off and thrown back in the hopper and attain a life of their own. Here are 14 items that are in the proposed budget that would have an impact on retirement plans.

1. Eliminate the Tax Arbitrage for Employer's Stock in an Employee's Qualified Plan

Under existing law, net unrealized appreciation (NUA) is a benefit when an employee hold appreciated stock of his employer in his retirement accounts. This modification would drop this favored tax treatment of employer stock in retirement plans. The changes would reinstitute the ordinary income tax rates paid on retirement distributions, as opposed to long-term capital gains rates. Under current law, to be eligible to use the provision, you must have appreciated stock of your employer (or former employer) inside your employer (or former)-sponsored retirement plan. There is a safe harbor: Any plan participant aged 50 or older by the end of this year (2015) would still be eligible for the special NUA tax treatment.

2. Limit Roth Conversions to Pre-Tax Dollars

After-tax money held in traditional IRAs or employer-sponsored retirement plans would no longer be eligible for conversion to a Roth account. Previously, taxpayers that have been restricted from making contributions directly to Roth IRAs (because their income exceeded their applicable threshold) have instead made contributions ' often non-deductible (after-tax) ' to traditional IRAs, then, shortly thereafter, converting those contributions to Roth IRAs. This two-step process would no longer be available.

3. Synchronize the Distribution Rules for Roth IRAs with the Rules for Other Retirement Accounts

The Administration seeks to impose required minimum distributions for Roth IRAs in the same way they are imposed for other retirement accounts. In other words, this proposal would require the taxpayer to take distributions from their Roth IRA once they turn age 70'; in the same way they would for their traditional IRA and other retirement accounts. If the taxpayer is 70' at the end of this year (2015), they would be exempt from the changes that would be created by this proposal. To change the rules now, after people have already made these decisions, would be inappropriate and not a large revenue generator. There is no equitable reason for changing the Roth distribution rules other than another attempt to move toward income redistribution.

4. Eliminate RMDs If Total Savings in Tax-Favored Retirement Accounts Is $100,000 or Less

It is proposed that if taxpayers' retirement accounts are under $100,000, then the distributions would be completely exempt from required minimum distribution (RMD) rules. Defined benefit pensions paid in some form of a life annuity would be excluded from this calculation. Under the proposal, the qualifying taxpayer would have no limitations or requirements of distribution.

5. Now You See It Now You Don't: 28% Maximum Tax Benefit for Contributions to Retirement Accounts

The maximum tax benefit (deduction or exclusion) is scheduled to a cap of 28%. A taxpayer in the 28% income tax bracket or lower would be unaffected by this provision. However, if the taxpayer is in a higher tax bracket, up to a 39.6% ordinary income tax bracket, the taxpayer would not receive a full tax deduction (exclusion) for amounts contributed or deferred into a retirement plan. According to the Greenbook , if a tax benefit for a contribution to a retirement plan was limited by this proposal, it would create basis in the retirement account. This course of action is to generate more tax receipts and creates a reporting nightmare full of complexities at a time when the Internal Revenue Service is unable to administer even the existing reporting rules. An additional headache is how this will integrate with local state tax regimes.

6. Establish a 'Cap' On Retirement Savings Prohibiting Additional Contributions

The administration is placing a ceiling over retirement funds that would prevent employer or employee funding when an arbitrary level is reached. This cap would be calculated by determining the lump-sum payment it would take to produce a joint and 100% survivor annuity of $210,000 per year, beginning when the taxpayer turns age 62. Currently, this would cap retirement savings at approximately $3.4 million. This is arbitrary and caprious as it is not tied into a region's different costs of living and is solely driven by the mantra of redistribution of wealth.

7. Providing the Long Term Unemployed Access to Retirement Funds Without Incurring a Penalty

This would exclude tax penalties on distributions from any form of retirement plan, including IRAs, whenever the taxpayer has been unemployed for 26 weeks or more, and has received unemployment compensation coverage at the local level. Furthermore, the distribution would have to occur in either the year the unemployment compensation was paid, or the following year. Finally, the exception would be limited to certain amounts. This does not relieve the participant from paying taxes on the distribution, but it does forego the penalty.

8. Mandatory Five-Year Rule For Non-Spouse Beneficiaries

The existing law permits beneficiaries of IRAs to extend the distributions from inherited IRAs over a substantial period of time ' by the end of the fifth year after the account owner's death. In contrast, today such beneficiaries are generally able to extend distributions from their inherited retirement accounts over their life expectancy. Distributions would be larger, putting beneficiaries into higher tax brackets and reducing their access to deductions, credits and other benefits that phase out in the higher brackets

9. Allow Non-Spouse Beneficiaries to Complete 60-Day Rollovers for Inherited IRAs

This tax proposal is a simple one. It brings parity to beneficiaries of inherited IRAs. Non-spouse beneficiaries would be allowed to move money from one inherited retirement account to another via a 60-day rollover, in a similar fashion to the way retirement account owners can move their own savings. There should be no objection to including such a provision in the tax code, as the budget consequences would be “negligible.” It would eliminate one of the most common, unintentional mistakes that affect IRAs.

10. Require Retirement Plans to Allow Participation from Long-Term Part-Time Workers

The budget expands coverage to for 401(k) plans so that a part time employee that has 500 hours of employment each year for a three (3) year period can make employee contributions into an employer's sponsored plan. The use of this approach is more expensive than the ability to put funds into an IRA either employer funded or employee funded.

Conclusion

There are other retirement-like modifications, such as with corporate owned life insurance (COLI). For contracts entered into or material modified by face amount or covered employees, there would be a limitation imposed on the interest deductions. This would also adversely affect the retirement and welfare benefits made available by employers. We continue this article next month with a discussion of 401(k) plans, ESOPS and more.

Lawrence L. Bell, JD, LTM, CLU, ChFC, CFP', AEP, has served as Tax Bar liaison to the IRS for 10 years. He has received patents in actuarial product fields dealing with COLI, GASB, FASB, IASB and OPEB solutions.