Obama budget targets education and retirement savings tax incentives

The Obama administration has proposed changes to education and retirement savings tax incentives—changes that would repeal Coverdell education savings accounts (ESAs), limit the tax deductibility of retirement savings plan contributions, and prohibit Roth IRA contributions after age 70½. These changes, which are detailed in the administration’s fiscal year 2016 revenue proposals, support the President’s vision of middle class economics—an agenda designed to ease the tax burden on low-income families and ensure that working families can afford the cornerstones of economic security, like education and retirement.

This is the first time that the Obama administration has proposed changes to Coverdell ESAs and Internal Revenue Code Section (IRC Sec.) 529 college savings plans. Many of the proposed changes to retirement savings tax incentives have been included in previous administration budget packages.

The $4 trillion budget package outlines an ambitious agenda to trim education and retirement savings tax incentives and increase domestic and military spending. The latter of which would be funded in part by higher taxes on upper-income taxpayers and corporations. That said, the budget proposals are the administration’s “wish list” and are unlikely to be adopted as proposed. But the President’s proposals should not be overlooked, as some will likely find bipartisan support and could be adopted or used to offset other spending.

Following is a summary of the major education and retirement savings proposals in the Obama administration’s fiscal year 2016 revenue proposals.

Repeal ESAs and Eliminate Tax Benefits for 529 Plans

No new contributions to ESAs would be allowed. Distributions of earnings on contributions to IRC Sec. 529 plans would no longer be excluded from gross income; however, the administration has reportedly abandoned that proposal due to widespread opposition.

Apply Required Minimum Distribution (RMD) Rules to Roth IRAs

Roth IRAs would be subject to the same RMD rules as Traditional IRAs. The proposal would require IRA owners to receive RMDs from Roth IRAs in the year they attain age 70½. The administration also proposes to prohibit Roth IRA contributions after reaching age 70½.

Require Certain Employers to Offer an Automatic IRA Option

Employers with ten or more employees, and in business for at least two years, would be required to offer an automatic IRA option. Employers sponsoring a qualified retirement plan, SEP, or SIMPLE plan would not be required to offer an automatic IRA option. Under the administration’s proposal, regular contributions would be made to an IRA on a payroll-deduction basis. The employer would facilitate employee contributions using its existing payroll-deduction system, but no employer contributions would be required.

Cap Tax-Advantaged Retirement Savings Plan Accumulations

Contributions to tax-advantaged retirement savings plans (such as IRAs, 401(a) plans, 403(b) plans, and governmental 457(b) plans) would be prohibited for individuals with accumulated assets past a certain threshold. That threshold is the amount necessary to provide the maximum annuity permitted for a tax-qualified defined benefit plan (currently $210,000). For an individual age 62, this amount is approximately $3.4 million.

Limit the Tax Deductibility of Retirement Savings Plan Contributions

The tax value of the exclusion for employee contributions would be reduced to a maximum of 28 percent for defined contribution retirement plans and IRAs, instead of allowing taxpayers to exclude the contributions from the full 33 percent, 35 percent, or 39.6 percent that they would otherwise owe. Taxpayers in the 28 percent and lower brackets would be unaffected. This same provision also would limit the tax value of contributions made by these upper-income taxpayers to health savings accounts and Archer medical savings accounts.

Limit Payout Options for Nonspouse Beneficiaries

Nonspouse beneficiaries of retirement plans and IRAs would be required to take distributions over a period of five years or less. Under current law, a nonspouse beneficiary may be able to take payments over his own life expectancy, depending on the original IRA owner’s date of death and whether there is a designated beneficiary under the plan.

Allow Nonspouse Beneficiary Rollovers to Inherited IRAs

A nonspouse beneficiary moving inherited plan or IRA assets to an inherited IRA would have the option to roll over such assets within 60 days. Under current law, this is not an option.

Eliminate RMDs

RMDs would be eliminated if the aggregate value of an individual’s IRA and other tax-favored retirement plan accumulations does not exceed $100,000 on a measurement date. The RMD requirements would phase in ratably for individuals with aggregate retirement benefits between $100,000 and $110,000.

The move to target education and retirement savings tax incentives reflects the Obama administration’s belief that current tax incentives are skewed to favor the wealthy and should be more focused on lower- and middle-class taxpayers. The administration also believes that retirement savings tax incentives are designed primarily to provide retirement security for participants and their spouses, not to transfer wealth to their beneficiaries.

Few expect that the President’s budget will be adopted as proposed. This is especially true now that Republicans control both houses of Congress for the first time since the President took office and given that may of his proposals were included in previous budget packages and were not acted upon. Even the White House acknowledges that the budget proposals start the process of negotiations, but is confident that agreement can be reached on a number of individual proposals that have bipartisan support. This could result in individual proposals that target education and retirement savings tax incentives being added to a final budget bill.

Congress now has until April 15 to produce its own budget, with the House and Senate agreeing on spending levels. Senate Budget Committee Chairman Mike Enzi (R-WY) has already announced that his goal is to finish the budget before the April 15 deadline. Stay tuned.