President’s FY 2014 budget proposal would impose cap on total accruals of tax-favored retirement benefits

President Obama’s fiscal year 2014 budget proposal would impose a limit on the total accrual of amounts in qualified plans and IRAs.

CCH Note: The FY 2014 budget request, unveiled on April 10, 2013, also contains proposals to establish automatic IRAs and to increase the tax credit for small employer plan start-up costs, proposals similar to those contained in earlier budget requests. The budget request also retains a proposal from last year’s request that would limit the rate at which deductions and exclusions related to retirement saving reduce a taxpayer’s income tax liability to 28%. The proposal to cap retirement accruals, however, is new.

$3 million cap

Under the budget proposal, a taxpayer who has accumulated amounts within the tax-favored retirement system (i.e., IRAs, qualified plans, 403(b) plans, and funded 457(b) arrangements maintained by governmental entities) in excess of the amount necessary to provide the maximum annuity permitted for a defined benefit plan under current law (currently an annual benefit of $205,000 payable in the form of a joint and 100% survivor benefit commencing at age 62 and continuing each year for the life of the participant and, if later, the life of the participant’s spouse) would be prohibited from making additional contributions or receiving additional accruals under any of those arrangements. Under current rules, the maximum permitted accumulation for an individual age 62 would be approximately $3.4 million. The proposal would be effective with respect to contributions and accruals for taxable years beginning on or after January 1, 2014.

According to the Administration, a change is needed because current rules “do not adequately limit the extent to which a taxpayer can accumulate amounts in a tax-favored arrangement through the use of multiple plans.” Such accumulations can be considerably in excess of amounts needed to fund reasonable levels of consumption in retirement and are well beyond the level of accumulation that justifies tax-advantaged treatment of retirement savings accounts, the Administration contends.

The limit would be determined as of the end of a calendar year and would apply to contributions or accruals for the following calendar year. Plan sponsors and IRA trustees would be required to report each participant’s account balance as of the end of the year as well as the amount of any contribution to that account for the plan year. If a taxpayer reached the maximum permitted accumulation, no further contributions or accruals would be permitted, but the taxpayer’s account balance could continue to grow with investment earnings and gains. If a taxpayer’s investment return for a year was less than the rate of return built into the actuarial equivalence calculation (so that the updated calculation of the equivalent annuity is less than the maximum annuity for a defined benefit plan), there would be room to make additional contributions. In addition, when the maximum defined benefit level increases as a result of the cost-of-living adjustment, the maximum permitted accumulation will automatically increase as well. This could allow for a resumption of contributions.

If a taxpayer received a contribution or an accrual that would result in an accumulation in excess of the maximum permitted amount, the excess would be treated in a manner similar to the treatment of an excess deferral under current law. Thus, the taxpayer would have to include the amount of the resulting excess accumulation in current income and would be allowed a grace period during which the taxpayer could withdraw the excess from the account or plan in order to comply with the limit. If the taxpayer did not withdraw the excess contribution (or excess accrual), then the excess amounts and attributable earnings would be subject to income tax when distributed, without any adjustment for basis (and without regard to whether the distribution is made from a Roth IRA or a designated Roth account within a plan).

Taxpayers affected

The Employee Benefits Research Institute (EBRI) has attempted to gauge the impact of the White House proposal. In its IRA database at year end 2011, approximately 0.03% of the accounts had more than $3 million in assets. The EBRI noted that some employment-based retirement accounts, such as 401(k) plans, would be affected as well. An analysis based on the projected year-end 2012 account balances on all participants in the EBRI/ICI 401(k) database with account balances at year-end 2011 and contributions in that year finds that approximately 0.0041% of those 401(k) accounts had $3 million or more in assets by year end 2012.

Taking into account combined IRA and 401(k) balances, a review of the integrated database as of year-end 2011 for individuals age 60 or older who had at least one IRA or 401(k) in 2010 and at least one IRA or 401(k) in 2011 finds that about 0.107% of these individuals had balances totaling $3 million or above, the EBRI found. Further, the EBRI noted, “those balances will change over time, and inflation is expected to increase the level of the cap.”

Reaction of employer groups

A number of employer groups were critical of the retirement cap proposal. The ERISA Industry Committee (ERIC) characterized the proposal as “ill-advised.” ERIC president and CEO Scott Macey noted that policymakers “should keep in mind that most monies saved in retirement accounts are tax deferrals, and will eventually be subject to taxation.”

The Plan Sponsor Council of America (PSCA) said that the proposal will introduce new complexities into the system. “Administration of this limit will be extremely complex, causing business owners to reconsider their decision to offer a plan,” said Bob Benish, the PSCA’s interim president and executive director. The American Society of Pension Professionals & Actuaries (ASPPA) also condemned the proposal, calling it a “plan killer.”

“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,” said ASPPA president and CEO Brian H. Graff.

Source: General Explanations of the Administration’s Fiscal Year 2014 Revenue Proposals, Department of the Treasury, April 2013. EBRI press release, April 10, 2013. ASPPA press release, April 5, 2013. ERIC press release, April 10, 2013. PSCA press release, April 10, 2013.

For more information on this and related topics, consult the CCH Pension Plan Guide, CCH Employee Benefits Management, and Spencer’s Benefits Reports.

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