Recently President Obama released his 2017 budget proposal and, as with all budgets issued by lame duck presidents, it was considered to be dead on arrival. However, Steve’s guest Kevin McCormally, Senior Vice President at Kiplinger, tells us a different story.
So often these annual budget recommendations, although not acted upon for several years perhaps, are pulled out by Congress at a later date for various reasons. A good example happened on Halloween night 2015 when Congress closed a “surprise” benefit known as “file and suspend” which stipulated that a wage earner could file for Social Security benefits and then suspend payments until a later date for himself, but his spouse could, at that point, begin receiving benefits based upon the wage earner’s retirement credits. Congress, in fact, closed this option as of April 29 of this year during that Halloween dead of night session.
Kevin’s advice is to keep an eye on some items in the proposal that the government might perceive as loopholes and take advantage of them while you can. It’s perfectly legal, and they could be eliminated at any time for various reasons, such as when Congress wants to decrease taxes in one area and increase them somewhere else.
Kevin’s article in Kiplinger mentions the back door Roth IRA as being vulnerable to these budget cuts. As it stands now, higher income people can convert their after-tax money from a traditional IRA into a Roth IRA, circumventing the restrictions on after-tax money for the wealthy. The government is always trying to stay one step or more ahead of wealthy people to unfairly, in their eyes, use these programs to increase their wealth and “cheat” the government.
In addition, there are other threatened features of IRAs, 401(k)s, and other retirement plans that could be on shaky ground, so Kevin advises looking out for these and acting upon them while you still can. To get the whole story, go to Kiplinger.com.
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Steve Pomeranz: Kevin McCormally is Chief Content Officer and Senior Vice President at Kiplinger. He is the author and editor of many books on taxes, retirement, and personal finance issues, and today we are going to sift through some of Obama’s budget proposal to see what it would mean if some of this stuff actually were to actually get enacted. Welcome to the show, Kevin.
Kevin McCormally: Thanks very much, Steve. I’m happy to be here.
Steve Pomeranz: So, Kevin, every year the president sends out his budget recommendations, and they are so often just dead on arrival. Is this one any different? What should we look forward to? Is there a reason we should pay more attention to this one?
Kevin McCormally: Well, this one is different, but mainly because people say that it was dead before arrival since it’s Obama’s last year. But the issue here on the budget is it’s not necessarily stuff that’s gonna happen this year, but we usually find that provisions, proposals, they come back to life in future years. What we looked at at Kiplinger is, with these seven items that are threatened, is these are things that the government thinks are too good a deal for taxpayers. They want to close these loopholes. If you can take advantage of ’em now, you better because sometime down the road these are gonna disappear.
Steve Pomeranz: Well, they actually did make one change on what they consider to be an aggressive Social Security claiming strategy. You want to discuss that for a second?
Kevin McCormally: You know that’s another one that two years ago that showed up in Obama’s budget. Nothing happened. Congress didn’t do anything, and then on Halloween night, in the dead of night, Congress closed what they call, “file and suspend.” It’s a great opportunity for people who are going to be 66 before May 1st of this year because they closed the loophole, but they said you can keep doing it for 6 months. File and suspend allows someone who will be 66 by May 1st of this year to file for their benefits, and then immediately say “I don’t want the money.” Why would you do that? Because as soon as you file, it lets your spouse file for spousal benefits based on your record. By suspending, you get to collect the late retirement credits for the next 4 years.
Steve, I just did this myself this week. I’m 66 this weekend, I filed and suspended. My wife then will be able to step up to a spousal benefit of about $1,500 a month. She only gets $600 a month based on her own record, but she can do a spousal. She’s gonna collect an extra $600 a month, and I get to continue to work for 4 years, if I can, and get this 8% a year delayed retirement credit.
Steve Pomeranz: When does that window close?
Kevin McCormally: That window closes on April 29th. You must file and suspend by April 29th and you have to be 66 by May 1st of this year to do it. If your birthday is after May 1st, you’re locked out.
Steve Pomeranz: We’ve been recommending file and suspend for many years now, and we are quite aware of this. Now you also mentioned in your article the back door Roth IRA. What is that?
Kevin McCormally: This is a big one, you know. No matter how much income you earn, you can contribute to a traditional IRA. Well, when they created the Roth IRA, which is the one that half the tax money goes in, that all withdraws are tax-free in retirement. They put an income gap. They didn’t want wealthy people taking advantage of this, and they said if you make more than about $117,000 on a single return or more than $184,000 on a joint return, you can’t contribute to that. But they also said that you can take your money in a traditional IRA and convert it to a Roth IRA.
Steve Pomeranz: Yes, with no limitation.
Kevin McCormally: The back door Roth is simply for higher income people. They put their money into a traditional IRA and immediately convert it to a Roth IRA, completely legal, but there are people who think, “Wait a minute, that’s not what we meant”, and that’s what they want to put an end to and prevent that sort of conversion of any after-tax money into a Roth for higher income people. That’s why we think higher income people who like Roth’s should be taking advantage of it now.
Steve Pomeranz: One of the features of an IRA, too, is that when it passes to beneficiaries, you can spread those payments out over the beneficiaries’ lifetime. It’s called the Stretch IRA. Isn’t there something in the budget that’s going to try to end that as well?
Kevin McCormally: Absolutely. And this is another one that people decided this is their loophole. Part of it is because people like you and people like Kiplinger and people like advisors keep saying this is a great deal. If you can leave an IRA to a child who then draws it over his/her lifetime and gets to stretch that tax shoulder, it can be worth a fortune. So banks decided, “Wait a minute”, except for spouses, widows, and widowers would be allowed to continue to stretch the IRA, or actually to even roll the money into their own IRA. But, in any event, they inherited money over their lifetime stretching the tax bill, maybe over decades. But anybody else under their proposal, they either have to take the money out within 5 years, all of it, I’m sorry, that is what they require. They are required to clean out the account within 5 years. Congress doesn’t want that tax shoulder extending for a long time for anybody except the first person. They say we design these things for your retirement, so you know it’s for your retirement, when you’re dead the tax shoulder ends.
Steve Pomeranz: My guest is Kevin McCormally, and we are discussing some of the features in President Obama’s 2017 budget recommendations that will most likely not be enacted, but watch out for these 11th-hour moves on Congress’s part. Because I guess, in a sense, you’re saying, Kevin, that these kinds of ideas plant the seed, and it’s places for Congress to go if they want to decrease taxes— one place they have to offset it with increasing taxes somewhere else. So these may be good food for fodder, in that particular case.
Kevin McCormally: Absolutely. And the other thing—I can’t emphasize this enough—taxpayers have got to keep an eye on what lawmakers seem to be thinking are loopholes because those are threatened. And whenever they’re threatened, you need to look out and say, “Wait a minute, can I take advantage of that now?” There’s nothing wrong with doing that. You’re supposed to advantage of every break in the law you can. It’s there, it’s legal. They’re thinking about closing it, so that should force you to say, “Let me take a double look at that, and see if, maybe, I should be taking advantage of it.”
Steve Pomeranz: Very good. Now a lot of people who, especially, if you own your own business, you look and, as you get closer to retirement, you look to set up a defined benefit plans, which allow you to put in a sizable amount of money into the retirement plan, get a nice tax deduction for it based on the amount of income that you would expect to receive in future years. There’s a proposal in the budget to change that as well, right?
Kevin McCormally: Well, there’s a rule right now that So for defined benefit plans, they can only set aside enough money to pay a benefit up to a certain amount, and it’s about $210,000 now. They say that’s enough for you to have in retirement, for anybody to have in retirement and get a tax break for it. So defined benefit plans are capped, the contributions are capped, at how much money you would need to pay out the $210,000, but there’s no limit on defined contribution plans like 401K’s and IRA’s. You could build up tens of millions of dollars in those things, and now they’re saying, “Wait a minute, we don’t want you to have any more in a defined contribution plan then it would pay to produce a $210,000 annual benefit for the rest of your life, starting at age 62.” If you do the math now, right now that’s about $3.4 million. If you’ve got $3.4 million today and you’re 62, that will buy you $210,000 of annuity income for the rest of your life. So, they’re saying if you’ve got that much now, you can’t put anything else in it, for the future.
Steve Pomeranz: And that’s for defined contribution plans like 401K’s, right?
Kevin McCormally: Right, for defined contribution plans.
Steve Pomeranz: So what Kevin is basically saying is, they’re saying, you know, look we don’t people building up $5 million or $10 million in these 401K’s. We’ve determined that based on annuity rates, that $210,000 of income is quite sufficient for you; therefore, how much capital would you actually need to produce that throughout a lifetime is $3.4 million, therefore, the amount of total value that you can have in your 401K would be that $3 million plus. Is that correct?
Kevin McCormally: That’s exactly right, Steve, but what they’re saying is if you’ve got more than that in the account when the law changes, you can keep it and it will continue to earn tax deferred…
Kevin McCormally: Therefore, keep shoveling it in while you can.
Steve Pomeranz: That’s right, so this is not only telling you a little bit about what could happen in the future, but it’s also giving you the opportunity as you listen to this to make those moves now before they shut down, I guess what some people consider to be loopholes.
Kevin McCormally: That’s absolutely right. They say we set up these tax breaks for retirement accounts because we want to help people save for retirement. We don’t want rich people hiding money in these accounts to pass on to their heirs. They’re saying, “Let’s use these accounts for their intended purpose to encourage people to save for their own retirement, so they can have a really good, financially secure retirement, but we don’t want to create a tax shelter for future generations.”
Steve Pomeranz: Yeah, I guess it’s just that where the cutoffs are, where the government thinks who is a rich person, is a little bit low in my view.
Kevin McCormally: Well, you know, go back to Social Security. When they first decided to start taxing Social Security benefits, they decided they’d tax them if your income was over $25,000 a year. That’s a rich person, and that was never adjusted for inflation, so it’s still $25,000.
Steve Pomeranz: Got it. My guest, Kevin McCormally from Kiplinger.com, and, Kevin, this is an article that you wrote. Where will they find this article?
Kevin McCormally: They can find it at Kiplinger.com. It’s Seven Retirement Breaks That Are Threatened by the Obama Budget. If you just search Obama budget, you’ll find it. (Or click here.)
Steve Pomeranz: Very good. Search Obama budget. Go to Kiplinger.com to find it. Kevin, thanks for spending your time to join us. Take care.
Kevin McCormally: Thank you, Steve.