An interesting item from Politico hints that your retirement accounts may not be as tax-free as you would like. From the Obama administration’s description of its new budget proposal:
“Sets limits on tax-preferred retirement accounts for millionaires and billionaires: The budget will also show how we can provide targeted tax relief to strengthen the economy, help middle class families and small businesses and pay for it by eliminating tax loopholes and make the tax system more fair. The budget will include a new proposal that prohibits individuals from accumulating over $3 million in IRAs and other tax-preferred retirement accounts. Under current rules, some wealthy individuals are able to accumulate many millions of dollars in these accounts, substantially more than is needed to fund reasonable levels of retirement saving. The budget would limit an individual’s total balance across tax-preferred accounts to an amount sufficient to finance an annuity of not more than $205,000 per year in retirement, or about $3 million in 2013. This proposal would raise $9 billion over 10 years.
We’re not going to argue for or against the wisdom of this policy proposal. Rather, we’re going to let it serve as a reminder that when setting up your retirement plans, there is an element of risk you need to take into consideration, and that is political risk. In this case, we’re talking about the risk that the tax-free aspect of IRAS, 401(k)s, and other retirement accounts will only last as long as they serve the purpose of the powers that be.
Right now, for example, you can take money out of a Roth IRA tax-free. Given our debt-to-GDP levels and the need for revenue to service that debt, we will be pleasantly surprised if everybody can still take money out a a Roth IRA tax-free in 30 years. The tax-free aspect of retirement accounts is not sacrosanct.
If it seems unthinkable to you that the Feds might start taxing Roth IRAs, then you’re probably not Australian:
Any income over A$100,000 drawn from a superannuation fund (the equivalent of an IRA in the United States) will now be taxed at 15%. Previously, all such income was tax-free.
Three questions for you to ponder:
- Knowing what you know of how politics works, do you think that Australia’s $100,000 income cutoff will remain the same… or that it might go down?
- Do you think that 15% tax rate will remain the same… or go up?
- Do you think there’s a chance that someday the United States Congress will change the rules so as to generate more revenue from “tax-free” retirement accounts?
(H/T: FWF)
Re Australia, their contributions to Supers are nearly all with pre-tax dollars and contribution limits are much greater there than here. By allowing tax-free withdrawals, a fair bit of income was completely escaping the tax system.
While your point about US tax risk is entirely appropriate, the Australian analogy is only partially apples-to-apples.