An old adage says the only two certainties in life are death and taxes. President Barack Obama is proposing a new twist: accelerated taxes on retirement savings after death.
Obama wants to change the way the government taxes 401(k) retirement plans and individual retirement accounts belonging to ordinary Americans and the rich alike when they pass to certain heirs.
The popular 401(k) plans and IRAs offer tax-deferred savings for retirement. Financial assets in these plans grow in value over time, but are taxed only when account holders retire and begin taking money out.
The proposed changes wouldn’t affect spouses who inherit the retirement plans. They target other beneficiaries — children, siblings or partners of the deceased — by forcing them to take the money out of the inherited account within five years. That brings the government more tax money up front.
It also requires heirs to take the money in larger chunks, which in some cases could bump them into higher tax brackets.
“The only exceptions would be disabled or chronically ill individuals, someone who is not more than 10 years younger than the participant or an IRA owner or a child who has not reached” legal adulthood, said an analysis by the website Benefitspro.
Heirs falling under those exceptions could still take the inherited money out of the accounts over the course of their lives. Presently, a non-spousal heir receiving $200,000 in a retirement account can take it all at once and pay taxes on it, draw down $10,000 a year for 20 years or do so under any time frame of their choosing.
If the Obama proposal becomes law, that $200,000 would have to be disbursed within five years, and not only is tax revenue pulled back more quickly but heirs also have fewer choices in how to take money that might affect their own tax statuses.
For example, a single taxpayer pays 10 percent on taxable income up to $9,225, 15 percent on the income up to $37,450, 25 percent on income up to $90,750, 28 percent on income up to $189,300 and 33 percent up to $411,500.
A Treasury Department official, speaking only on the condition of anonymity as a matter of policy, said the goal was to bring these plans “more in line with the intent of the tax preference for retirement savings.”
Tax wonks agree.
“The point . . . is to save for retirement, not to provide a windfall tax savings to your heirs,” said Leonard Burman, director of the Tax Policy Center, jointly run by the center-left Brookings Institution and the centrist Urban Institute. “The biggest benefit under the current policy is for (older men) who marry (young) wives and have young kids . . . who’d be getting tax-deferred benefits for 30 or 40 years.”
That’s certainly the case now, but as more Americans born from 1946 to 1964 hit retirement age, these baby boomers are more likely than past generations to have more in tax-deferred retirement accounts that might outlast them and pass to heirs. The 401(k)s and IRAs took off in the late 1980s and have since replaced traditional pension plans.
Obama’s proposal also would be a windfall for government coffers, raising a projected $5.4 billion over 10 years, according to his budget plan.