Obama's Proposed IRA Cap: Sending The Wrong Message?

by: Chip Castille

As part of his budget proposal, President Obama has suggested capping the tax deferral benefit of Individual Retirement Account (IRA) and 401(k) balances at $3 million. All the details aren’t clear yet, but it’s safe to assume that investment returns on some portion of the portfolio over the cap would be subject to current year taxation. It is not a hard dollar limit; the proposed cap is tied to the cost of buying an annuity that would generate $205K annually. That means the cap would move with interest rates.

While it is not clear whether the proposal will pass, let’s look at the numbers involved and the impact they might have:

  • Only 0.03% of the 20.6 million IRAs have more than $3 million, according to the Employee Benefit Research Institute (EBRI).[1]
  • Only 0.0041% of 401(k) accounts have more than $3 million, according to the same EBRI report.
  • $3 million, according to BlackRock’s proprietary retirement income calculation, would translate into $166k per year. (An income that would put you in the top 7% of US earners).[2]
  • If rates rise to their 2006 levels, the cost of buying a $205K annuity would drop the threshold to as low as $2.2 million, which would affect 3% of 401(k) accounts.

Of course, even at that level the cap would not immediately affect many people in a material way. But I wonder if this proposal muddies the message the government wants to send about retirement. Younger savers have more time to invest and therefore may have a greater chance of bumping up against the cap in the future. Do we really want to take away incentives to save and invest?

The current gap in retirement savings in the US—the difference between what people have saved and what they need to save for retirement—is estimated at $6.6 trillion.[3] That means the average American family is on course to have less than two-thirds of the savings needed for retirement expenses.[4]

Employer sponsored savings plans and individual retirement accounts are a good idea even without the tax benefit. But given the importance of IRA and 401(k) plans in today’s retirement landscape, we need to be very careful about doing anything that might undermine the commitment to save.

[1] Advisory from EBRI, The Impact of a Retirement Savings Cap, April 12, 2013

[2] US Census Bureau; Income, Poverty, and Health Insurance Coverage in the United States: 2011

[3] Center for Retirement Resource at Boston College

[4] McKinsey’s study on retirement security; “Restoring Americans’ Retirement Security,” McKinsey, p. 2, based on 2009 data

Original post