Obama Budget Proposes Trimming Retirement Tax Incentives

by: Dennis Zuehlke, Compliance Manager, Ascensus

The Obama administration has proposed trimming tax incentives for contributions made by higher-income taxpayers to IRAs and defined contribution retirement plans in an attempt to reduce the federal deficit. The administration released details in the Fiscal Year 2013 Revenue Proposals.

The Obama administration has also proposed liberalizing IRA rules by eliminating required minimum distributions from IRAs that have balances of $75,000 or less and allowing nonspouse beneficiary indirect rollovers to inherited IRAs. Other administration proposals are intended to increase the savings participation rate for low- and middle-income workers, double the tax credit for small employer retirement plan start-up costs, and make the American opportunity tax credit a permanent replacement for the hope scholarship credit.

Under current law, certain types of income are permanently excluded or temporarily deferred from income subject to tax, including amounts paid by employees and employers for defined contribution retirement plans, such as IRC Sec. 401(k) and 403(b) plans. The administration’s proposal would limit to 28 percent the maximum tax reduction value of employee contributions to defined contribution retirement plans and IRAs for certain higher-income taxpayers. This is currently defined in the proposal as applicable to single filers with adjusted gross incomes of $200,000 or more, and if married filing jointly, adjusted gross incomes of $250,000 or more. This same provision would also limit the tax reduction value of contributions made by these higher-income taxpayers to health savings accounts and Archer medical savings accounts.

This is the first time that the Obama administration has proposed reducing the tax incentives for making retirement plan and IRA contributions. The proposal has already been met with opposition from the retirement industry and members of Congress. Representatives Jim Gerlach (R-PA) and Richard Neal (D-MA), both senior members of the House Ways and Means Committee, introduced a congressional resolution in the House seeking a “sense of the Congress” that current tax incentives for retirement savings should be retained in any reform of the tax code. The resolution has already garnered more than 106 cosponsors in the House.

The administration’s three previous budget proposals left retirement tax incentives untouched. The current move to trim retirement tax incentives sends a signal that the Obama administration may be widening its net in search of revenue. But this is not the first time that retirement savings incentives have come under the budget knife.

More than 25 years ago, the Tax Reform Act of 1986 (TRA ’86) restricted deductibility of IRA contributions for middle- and upper-income taxpayers covered by employer-sponsored retirement plans and permitted nondeductible contributions for taxpayers unable to claim full IRA deductions. As a result of TRA ’86, the number of taxpayers eligible to claim full IRA deductions fell sharply as did contributions to IRAs.

Credit unions that had experienced double-digit growth in their IRA programs after the Economic Recovery Tax Act of 1981 made deductible IRAs available to all taxpayers suddenly saw IRA contributions dramatically drop. IRA program growth at credit unions remained stagnant for the next 10 years, until the Taxpayer Relief Act of 1997 created Roth IRAs and education IRAs (now called Coverdell education savings accounts) and gave new life to their IRA programs. The current move to limit retirement tax incentives has many wondering if the result would be the same, at least among those with higher incomes.

It is important to note that the administration’s proposal has not yet been introduced in Congress, and many believe that if introduced, it would be unlikely to pass this year. However, much like the triple witching hour on Wall Street, this is a presidential election year—with the White House, one-third of the Senate, and the full House up for grabs—so volatility is the norm and anything can happen. So stay tuned.

Dennis Zuehlke is Compliance Manager for Ascensus® in Middleton, Wisconsin. Mr. Zuehlke provides clients with technical support on tax-advantaged accounts (including individual retirement accounts, health savings accounts, simplified employee pension plans, and Coverdell education savings accounts), and information reporting and tax withholding issues. Mr. Zuehlke is a frequent national speaker on compliance-related issues and retirement savings trends within the financial services industry.

Mr. Zuehlke attended Marquette University and graduated from the University of Wisconsin. Prior to joining Ascensus, he held a similar position with the Credit Union National Association.

Ascensus delivers a full range of retirement plan services—including plan administration, plan design and maintenance, consulting, web-based tools and content, software solutions, education and training, forms and documents, and technical resources—to approximately 9,000 financial organizations nationwide.  www.ascensus.com