President Obama has proposed to renew a previous tax rule to place a cap on the total amounts in combined individual retirement accounts. The proposal sets a limit of $3.0 million. The proposal keys the accumulation limit to the amount needed to provide an annuity of $200,000. The rule limits the total amount of contributions and accrued funds eligible for favored tax treatment; amounts beyond the retirement savings ceiling would not be tax-favored. The proposal would, in effect, place a limit comparable to the current defined pension benefits plan annuity limits of $205,000 or $3.4 million in total accumulations.

Current Law and Policy

Under current law, there is favorable tax treatment of accumulations in defined benefits accounts including IRA, 401(a), 403(b) and Roth IRA. The proposal defines the contribution limits in terms of annual amounts limits of $5,500 for Roth plans and $53,000 for 401(k) and up to $57,000 for persons over 50 and small business owners. Excess contributions must be removed or owners will get a tax penalty and pay ordinary income rates. However, the law does not limit the amounts individuals can accumulate in their combined IRA accounts. Some few individuals have accumulated more than $100 million which is far in excess of amounts needed for support and financial well-being.

The Proposed New Policy and Cap

The purpose of the new rule is to raise revenues. The Administration estimates that it can produce $9 billion in additional revenues over the next ten years. The policy suggests that is more equitable to shift tax burdens to those with greater wealth and reduce tax burdens on those with far less. The proposal would use a model of a purchased retirement annuity. Insurance providers would accept payment and fund an annuity by buying bonds. At today’s rates, a ten-year treasury note yields only 2 percent. In past decades, it has rarely dropped below five percent. At five percent, a $200,000 annuity would cost only 2.2 million. Under the proposal, funds in excess of $3.0 million would clearly not get favorable tax treatment; owners would have to move the excess funds into some other qualified account. The tax code treats some savings differently. While taxable, it may be taxed at lower rates than income. Many savers currently obtain capital gains rates as opposed to the higher ordinary income rates on excess contributions. The issue is whether the calculation of $200,000 is the limit or the goal. It is not clear whether the overall dollar limit drops as interest rates climb.

Unresolved Issues

The policy proposal presents a large number of issues, and interest rates are at the center of many of them. The overall purpose of the policy is to increase tax revenues by placing a reasonable limit on a tax exemption. The idea that under certain market conditions, a three million dollar retirement fund could purchase a retirement annuity worth $200,000 per year or more. However, without a fixed rate of interest, the annuity could cost more or less, conversely it could purchase far more if interest rates remain at their historic lows. Opponents argue that if interest rise the effective limit of $3m goes down to perhaps $2.2 million, and that would affect many more people than the $3 million limit. Since the Administration has not committed the precise, final wording of the revised proposal for review and comment, these issues will clearly be part of that discussion. Under the previous proposal, it appeared that the limit would be a function of the interest rate and $200,000 calculation; it would adjust downward with the applicable interest rate.