President Barack Obama’s latest plan to raise tax revenue from wealthy individuals would pinch tax- favored retirement accounts of some private-equity executives and self-employed professionals by capping them at $3 million.
The proposal, to be detailed in Obama’s budget April 10, would raise $9 billion for the government over the next decade, according to the White House. The issue of multimillion-dollar individual retirement accounts drew attention last year when Republican presidential nominee Mitt Romney disclosed that his IRA had a maximum value exceeding $100 million.
It’s not just private-equity executives who would encounter higher taxes under Obama’s proposal. Self-employed business owners, such as doctors and lawyers, can contribute up to $51,000 a year to their IRAs, making it relatively easy for them to hit $3 million over a career without unusual investment strategies, said Bobbi Bierhals, a partner at McDermott Will & Emery LLP in Chicago who specializes in estate planning.
“This is going to be seen as a disguised rate increase” that will alter estate and retirement planning, said John Olivieri, a partner in the private clients group of White & Case LLP in New York. “Clients have typically tried not to touch this money ever, because it’s subject to tax.”
Obama, who persuaded Congress to raise top marginal tax rates on ordinary income, capital gains, dividends and estates during his first term, is seeking more revenue from some of the same sources. His budget plan will include other revenue-raising proposals paired with spending cuts in a renewed pitch to congressional Republicans for a so-called grand bargain to trim the deficit.
“It’s one of the ideas that we need to look at as we need additional revenues,” said Representative Sander Levin, a Michigan Democrat who has warned of harm to defense programs and unemployment insurance from $1.2 trillion in federal spending cuts that began March 1.
IRAs are retirement accounts that let people contribute money without paying income taxes up front. The money grows tax- free inside the account, and holders must pay taxes at ordinary income rates when they withdraw. IRA owners can begin withdrawing money without penalty after they turn 59 1/2 and must start withdrawing money after they turn 70 1/2.
The typical household approaching retirement had $120,000 in combined 401(k) and individual retirement account savings in 2010, according to a July report by the Center for Retirement Research at Boston College.
The retirement savings cap would apply to the total of an individual’s tax-favored accounts.
A $3 million limit would be enough to finance an annuity of $205,000 in retirement. The White House said in an April 5 statement that under current law “some wealthy individuals” can accumulate “substantially more than is needed to fund reasonable levels of retirement saving.”
The administration hasn’t explained how the cap would work. Officials haven’t said whether they would tax existing balances above $3 million or prevent people from adding more money to their accounts once they reach that amount.
The White House also didn’t say whether the limit would be indexed for inflation or whether it would affect defined-benefit pension plans. While such plans pay benefits over time, their present value also can be calculated in a lump-sum amount.
Individuals typically aren’t required to report annual balances in their retirement accounts to the Internal Revenue Service, making it difficult to determine how many people would be affected.
During last year’s presidential campaign, Romney disclosed in public filings that his IRA held between $18.1 million and $87.4 million. At one point, the maximum exceeded $100 million. Romney, the co-founder of Bain Capital LLC, didn’t explain how he amassed that much money in an IRA.
Most taxpayers can contribute a maximum of $5,500 to an IRA for 2013. Older workers, self-employed people and those who save through 401(k)-style plans have higher caps and can roll those accounts into IRAs.
Obama appears to use such a plan, according to his tax return. The president, who made more money in 2011 from book sales than from his government salary, deducted a $49,000 contribution to a tax-advantaged retirement plan.
Disciplined savers in those plans with higher caps can reach $3 million in savings without unusual investment strategies, said Clint Stretch, senior tax policy counsel at Tax Analysts.
He said the proposal was “significant” without being philosophically different from the caps on tax-free contributions.
One possibility that might explain Romney’s accounts is that he may have included Bain investments valued at close to nothing that later grew exponentially. The value would increase tax free in the retirement account and would be subject to taxation at ordinary income rates when taken out.
Eric Fehrnstrom, a spokesman for the Romney campaign, didn’t respond to a request for comment. Brad Malt, Romney’s longtime personal lawyer, declined to comment.
IRAs have evolved from a retirement-planning technique into an estate-planning tool for some wealthy families because tax laws allow the accounts to be passed on to heirs, said Ed Slott, an IRA specialist and certified public accountant based in Rockville Centre, New York.
“It hit a critical mass when a lot of people found out that Romney had $100 million in his IRA,” Slott said. “People thought, how on earth did that happen? I think that was the tipping point.”
Heirs must pay taxes on inherited IRAs, though the payments can be stretched over a long period as the account holders are required to withdraw the money over their lifetimes.
Romney’s disclosures prompted congressional Democrats to call on the Treasury Department to explain how it enforces relevant tax laws and to offer policy recommendations.
One of those lawmakers, Levin, said in an interview that he found Romney’s retirement account abusive because it undermined the purpose of tax breaks for savings.
The Obama budget proposal is “an interesting alternative,” said Levin, the top Democrat on the tax-writing House Ways and Means Committee. “We need to look at it actively.”
Also unexplained is how the cap would affect a second category of retirement account, the Roth-style IRA. Owners have already paid income taxes on contributions to those accounts, meaning the money isn’t subject to taxation upon withdrawal.
“If this doesn’t apply to Roth IRAs, that’s going to make Roth IRAs even more attractive to the wealthy,” Bierhals said. If more people decide to convert some or all of their retirement savings to Roth accounts, that may generate more short-term revenue for the government, she said.
Brian Graff, executive director and chief executive officer of the American Society of Pension Professionals and Actuaries, said his group will “vigorously oppose” any limit on the size of IRAs.
“It is a ‘plan killer,’” he said in an e-mailed statement. “As business owners reach the cap, they will lose their incentive to maintain a plan, and either shut down the plan or greatly reduce benefits. This would leave workers with a greatly diminished plan or without any plan at all.”
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