Will the White House Put Account Limits on Your Roth IRA?

The Administration's Budget Proposal Calls for Limiting Roth IRA Balances

Roth IRA Account Balance Limits Congress
There is a lot of talk coming out of Washington, D.C. about limiting the maximum amount a person can amass in his or her Roth IRA. Chris Ryan / Caiaimage / Getty Images

In recent years, there has been a push by the White House in its suggested budget proposals to limit the amount of money individual investors can amass in their IRAs, including both the Traditional IRA and the Roth IRA.  Though Congress has refused to go along with it for now, there has been a lot of nervous chatter that the Federal government, which continues to set all-time spending records in both nominal and inflation-adjusted dollars, might someday eye those accounts you've been diligently growing to give you financial independence in your golden years.

Should you worry?  If the government does decide to implement an IRA tax or limit the amount you can build up in your IRA, what are the implications?  Let's look at some of the scenarios to see how this might play out for the typical investor.

What Might an IRA Tax or IRA Account Balance Limitation Look Like?

In most cases, the proposals have focused on setting a ceiling on the amount of money you could have in an IRA account and still receive the advantages of tax-free or tax-deferred compounding.  A number that has been thrown around more than a couple of times is $3,000,000 per taxpayer.  That is, if, through your IRA, you bought $100,000 worth of Starbucks shares in the IPO back in the early 1990's, and held on to them until today when they were worth almost $17,000,000, the IRS would force you to kick out $13,000,000 from the protective confines of the IRA itself, allowing you no more than $3,000,000 in the tax shelter.

In theory, Congress could get around this by weighting the balance relative to the IRA cap.  For example, if you have $5,000,000 in an account and the limit is set at $3,000,000, only 60% of your capital gains, dividends, interest, and other passive income will be tax-exempt.  Since the rules haven't been written, yet, and there is no guarantee they will even be changed, nobody really knows at this point.

 

How Many People Might Be Hit by an IRA Tax or IRA Balance Limit?

Here's the good news: If the government decided to tax your IRA, or limit the amount you can keep in an IRA, it probably won't have an impact on you or your family.  In the at-the-moment unlikely event Congress decides to implement an IRA tax or IRA limit, how many investors, specifically, would be hit with the levy or roadblock?  According to a September 2014 research paper by the U.S. Government Accountability Office, which examined IRA balance returns for tax year 2011 (the most recent year available), there are 43,013,341 IRAs in the United States.  Of these, the current estimates are:

  • 42,382,192 IRAs have a balance of $1,000,000 or less
  • 502,392 IRAs have a balance of $1,000,000 to $2,000,000
  • 83,529 IRAs have a balance of $2,000,000 to $3,000,000
  • 36,171 IRAs have a balance of $3,000,000 to $5,000,000
  • 7,952 IRAs have a balance of $5,000,000 to $10,000,000
  • 791 IRAs have a balance of $10,000,000 to $25,000,000
  • 314 IRAs have a balance of $25,000,000 or more

    Presumably, if the $3,000,000 IRA limit is used, only 45,228 IRAs would be hurt by the tax or lose some of the tax-shelter benefits.  That represents roughly 0.105% of all IRAs in existence, meaning approximately 99.999% of IRAs should be able to avoid the problem.

    The issue some investors are anticipating is the government's habit of letting inflation cause taxation levels to become regressive.  The IRA, especially the Roth IRA, has not been in existence for very long.  It is much more possible for an 18 year old joining the work force today to amass millions of dollars within an IRA 40 or 50 years from now than it is at present, having had the advantage of nearly half a century of compounding.  If the IRA limit were imposed but not raised, it could turn into a repeat of the alternative minimum tax, which was originally intended for the superwealthy but, instead, became the bane of upper middle class families as Congress became addicted to the revenue stream.

    What Are the Arguments in Favor of Limiting the Amount You Can Have in a Roth IRA?

    The biggest concern seems to be situations in which an investor enjoys outsized returns within a Roth IRA to the point it strikes taxpayers as unfair.  Forbes has written about the founder of Yelp, who managed to get shares of some startup companies inside of his Roth IRA.  They reported he was sitting on something like $100 million in his mid-to-late 30's, all parked in this magical tax shelter that will compound for decades without a penny going to pay for his share of the roads, schools, military protection, or other shared services he gets to enjoy.  On top of this, his children and grandchildren will be able to extend the tax-free advantage based on the way the current distribution rules are written (which dovetails nicely into our next question).  This is another of the reasons there has been a call to change the rules for the Roth IRA, which has no mandatory distribution age, to begin forced payouts starting at 70.5 years old just like its Traditional IRA counterpart.

    The critics maintain this is to avoid bad social policy.  The idea that someone could put $100,000,000 in, say, intermediate term corporate bonds and collect $3,500,000+ in tax-free income per year without doing anything, or contributing anything, feels, to them, a gross miscarriage of justice when you still have self-employed plumbers paying 40% or 50% of their income if they're successful enough to be toward the top of the income distribution scale while being unfortunate enough to live in a high-tax state, slapping another croupier's take off the household income pile.

    What Are the Odds an IRA Tax or IRA Account Balance Limitation Is Put Into Effect?

    With Republicans now controlling both the House of Representatives and the United States Senate, it seems highly unlikely the rules will changed anytime during the next 24 months unless it is part of some "grand bargain" that involves huge tax reform between the legislative branch and the Democratically-controlled White House.  

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