Obama Budget Would Drastically Alter IRA Rules

iStock_000011965294MediumPresident Barack Obama calls them loopholes, although investors consider them playing by the rules.

Yet under the president’s newly released budget, some of the tax strategies used by high-income earners to contribute to Roth IRAs or maximize the tax benefits on inherited IRAs would go away.

Right now, to make a full or partial contribution to a tax-friendly Roth IRA, income must be under $131,000 for an individual and $193,000 for a married couple. High earners have gotten around this by making nondeductible contributions — up to $6,500 a year for older investors — to a traditional IRA, which doesn’t have income limits as long as investors aren’t claiming a deduction. After that, they convert the traditional IRA to a Roth.

And thanks to an IRS clarification last fall, workers who are allowed to make after-tax contributions to their 401(k) plans can also roll that money into a Roth. In this scenario, after-tax contribution limits are even higher, so savers could sock away $30,000 or more a year into a Roth IRA.

Under the president’s proposal, these “back doors” into a Roth would be shut starting next year. Money contributed on an after-tax basis to a traditional IRA or retirement plan could not be converted to a Roth.

Of course, these changes would require the backing of Congress, which is unlikely to happen at this point, says Jeffrey Levine, an IRA technical consultant with Ed Slott and Co.

The president’s budget also brings back other proposed IRA restrictions that weren’t enacted.

For instance, the president would require that nonspouses who inherit IRAs — with a few exceptions — take all the money out of the account within five years. Currently, they can take distributions over their own life expectancy, which means the funds can remain in the account for decades and continue to grow while taxes are spread out.

The administration argues that these inherited IRAs were meant to provide retirement security to the original owner, not become a tax shelter for heirs.

The president once again proposes requiring owners of Roth IRAs to take minimum distributions after age 70½, as people do with traditional IRAs, 401(k)s and even Roth 401(k) accounts. On the other hand, he once more suggests that people who have a combined value of up to $100,000 in all IRAs, 401(k)s and retirement accounts be exempt from mandatory minimum distributions.

Another perennial proposal would limit the full tax benefit of retirement accounts and certain deductions to the 28 percent income tax bracket. Basically, those in the 33 percent, 35 percent or 39.6 percent bracket would owe some tax on 401(k) deferrals and other deductions, Levine says.

>> Get discounts on financial services with your AARP Member Advantages.

Some of the president’s ideas, though, might actually appeal to investors.

Currently, unemployed individuals can tap IRAs before age 59½ on a limited basis without triggering a 10 percent penalty. A new proposal would expand this, allowing the long-term unemployed — those out of work for more than 26 weeks — to withdraw money from IRAs and 401(k)s early without penalty. It would apply to distributions of up to $50,000 annually over two years.

Also new: If your employer offers an annuity through its retirement plan and later drops it as an investment option, you would be able to roll over that annuity into an IRA or other retirement plan, Levine says. Otherwise, a worker would be forced to liquidate the annuity, he says.

Photo: Kativ/istock

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17 comments
2Papa
2Papa 5pts

That is outrageous!  I am not voting for Obama again!

ejr1953
ejr1953 5pts

Here's a strategy some in "high finance" have used to get richer, while not paying taxes, or paying far less than most people.


Step 1: create a corporate entity.


Step 2: issue shares of stock in that corporate entity, collecting $1 for, say 10,000 shares.


Step 3: open and Roth IRA and place those 10,000 shares in it.


Step 4: have that new corporate entity purchase shares in another for-profit company.


Step 5: when the holdings of the first corporate entity increase in value, sell them, the increase in value not taxed.

InsertCleverNameHere
InsertCleverNameHere 5pts

This article makes it quite clear that the current tax code needs to be burned and replaced with a flat tax or national sales tax.  These loopholes and shelters do nothing but make the rich richer at the expense of everyone else.

paladin888
paladin888 5pts

Barack will not be happy until the last of the middle class is destroyed.

myexper
myexper 5pts

@ejr1953 

.......................  AND THEN THE COW JUMPED OVER THE MOON !!

ejr1953
ejr1953 5pts

Even if you don't fund a Roth with this strategy, you can fund a regular IRA and let the investment grow without taxation (until you withdraw from it).

BBoomerPharm
BBoomerPharm 5pts

Wouldnt it be great if we could have a flat tax, maybe 3 rates, with the only deduction charity?

Can you imagine??

But Democrats would fight to a bloody death before they would allow the government to be taken out of the social welfare business, , since they get virtually all their power from wealth redistribution. End social welfare, end the Democratic Party.

Ironic, isn't it, that the Left likes to criticize the Far right for denying evolution?

If Charles Darwin were alive today, he'd tell us the U.S. days as a Super power are numbered.

Any country that penalizes those exhibiting desirable traits such as hard work, discipline, saving money, and taking care of their bodies in order to reward those who exhibit traits that are destructive to society to the extent the U.S. now does, will not be a Super power for long.

myexper
myexper 5pts

@paladin888 

Please take the time to inform yourself and read the AARP article in the link below .... in the AARP article forums. The article describes another attempt of the President to help struggling middle class families. I say "attempt" because Republicans have already pledged to kill the President's middle class help.

http://blog.aarp.org/2015/01/21/obama-proposes-middle-class-tax-breaks/

The President's budget, which you falsely criticize, removes tax loopholes for the wealthy while providing assistance to middle class Americans.

myexper
myexper 5pts

@paladin888 

NOT TRUE!!

YOUR COMMENT COULD NOT BE FURTHER FROM THE TRUTH!

President Obama has consistently tried to help out the middle class. In his State of the Union address, the President proposed a $3000 tax credit per child for middle class parents. How is that destroying the middle class? But Republicans already indicated that they will kill this middle class tax cut.

And the Ryan Republican Budget, which would tax the middle class to death in addition to killing Medicare and annihilating safety nets for the poor, was condemned by the President.

Please become aware of WHO has done WHAT before making false accusations.

If you were an informed person, you would know that IT IS REPUBLICANS WHO WANT THE MIDDLE CLASS DESTROYED  .... ALONG WITH ALL NON WEALTHY SENIORS AND THE POOR.

Stoshie
Stoshie 5pts

@paladin888 And how does this proposal affect the middle class?

I don't really expect a rational answer.  People suffering from ODS (Obama Derangement Syndrome) rarely can think rationally about him.   But they are good at posting nonsensical comments about him, whether the story involves him or not!

myexper
myexper 5pts

@BBoomerPharm 

You contradict your own opinion. Having 3 tax rates is a graduated tax and not the flat tax you support.

And any country that dehumanizes and attacks its vulnerable citizens, as you do, will face the destruction you fear.

myexper
myexper 5pts

@BBoomerPharm 

Your criticism of ill people is irrational and inhuman. People can become ill through no fault of their own, especially seniors in the aging process.

myexper
myexper 5pts

@BBoomerPharm 

Continuing ...... Please take the time to read the Ryan Republican Budget before spewing out misinformed, fact deprived criticism. The Ryan Republican Budget would tax the middle class to death ..... to give the wealthy more money with enormous tax reductions paid for by the middle class. And this same Republican budget kills off the "charity deduction" you deem necessary.

BBoomerPharm
BBoomerPharm 5pts

Unfortunately Obamas definition of wealthy is your local orthodontist and his CPA wife, who now pay a top rate of 43% with little escape because virtually all their income is earned.

myexper
myexper 5pts

@BBoomerPharm 

NOT TRUE!

The "top rate" is 39.6%.  And this includes taxable incomes over $457,000.00, filing jointly  ..... hardly the "local orthodontist and his CPA wife".

In your eagerness to (falsely) criticize President Obama, you only show that you have no idea as to what you are talking about.


CrockettMC
CrockettMC 5pts

@myexper @BBoomerPharm

The highest marginal tax bracket may be 39.6% but people in this bracket are also subject to 3.8% Medicare Tax plus a .1% Additional Medicare Tax that was implemented in 2013.

Both of the above are in addition to the normal Medicare taxes of 1.45% on the first $200,000 in earnings and 2.35% on earnings above $200,000.  Also, the above taxes are applied to income other than earnings.

In addition, there is the 12.4% FICA tax on the first $118,500 of the husband's income and the wife's income.

So, a household with two self-employed members could easily be paying 50% of their income to various Federal taxes.