Washington is taking a hard look at tax-sheltered retirement
accounts, especially “supersize” ones worth millions of dollars. Savers should
consider what it could mean for them. The U.S. Government Accountability
Office, recently released a report on individual retirement accounts, requested
by Senate Finance Committee Chairman Ron Wyden (D., Ore.). Its publication
coincided with Senate hearings on retirement savings held last month.
The GAO study addressed questions many people asked after
disclosures that former presidential candidate Mitt Romney had a
traditional IRA worth as much as $101 million and technology entrepreneur Max
Levchin put more than 13.3 million shares of Yelp stock in a Roth IRA before
the firm went public in 2012.
How many supersize IRAs are there? The GAO estimates more
than 300 individuals or families have IRAs with balances greater than $25
million, while more than 9,000 have IRAs worth more than $5 million. The GAO
wasn’t able to distinguish between regular and Roth IRAs, given the data.
While both types of IRAs benefit from tax-free growth, there
are significant differences between them. Savers can often deduct contributions
to traditional IRAs or make tax-free rollovers of 401(k)-plan assets into them,
while contributions and rollovers to Roth IRAs must be made with after-tax
dollars.
There also are important differences for withdrawals. Mr.
Romney, for example, must begin taking annual withdrawals from his traditional
IRA at age 70½, with the payouts taxable at ordinary income rates up to about
40%. Withdrawals from Roth IRAs such as Mr. Levchin’s, however, are usually
tax-free, and there are no mandatory payouts for the owner.
How can IRAs grow so big? The GAO study said that to
accumulate $5 million in an IRA by making the highest allowed individual
contributions from 1975 to 2011, the assets would have needed to generate an
average annual return of 18%.
The final version of the GAO report, due in a few weeks,
will address strategies investors use to supersize their IRAs. Such moves
include using account assets to buy nontraded stock or partnership interests
that could balloon in value once inside the account, experts say.
The Internal Revenue Service also is interested in
supersizing strategies, as harsh penalties for “self-dealing” violations can apply
to investors who participate in businesses owned fully or in part by their
IRAs. To shine light in dark corners, the agency is changing reporting
requirements for hard-to-value IRA assets.
Starting with the 2014 tax year, brokerage firms and other
IRA sponsors will be asked to report such assets on Form 5498. The form asks
the sponsors to detail the fair-market value for each of several asset classes,
including real estate, nontraded debt or stock, or an interest in a
limited-liability company, partnership or trust.
This reporting is voluntary for this year, but it is
expected to become mandatory for 2015 returns, says Judy Miller, a retirement
specialist at the American Society of Pension Professionals & Actuaries.
Legislative changes for retirement plans also could be
afoot. One proposal with bipartisan support curtails the current “stretch”
feature, which allows IRAs to continue for decades after the original owner’s
death if the account is left to a much younger heir.
The proposal would limit the stretch provision to five years
after the owner’s death, unless the IRA is inherited by a spouse, with a few
exceptions. Ms. Miller says the provision has narrowly escaped twice before but
may not survive for long.
Comprehensive tax reform—which House Speaker John
Boehner (R., Ohio) recently said is a possibility next year—could well
bring changes to retirement plans, which receive tax breaks of about $140
billion a year. So far, experts say, none of the current proposals would impose
a tax on assets that already are in retirement plans, although several would
curtail contributions from higher-bracket taxpayers.
The bottom line: if you have an IRA that holds nontraded
assets, make sure to cross every “T” and dot every “I” for the IRS. Don’t count
on your IRA surviving you for many decades. And consider maximizing
contributions to tax-sheltered retirement plans now, while the tax benefits for
contributions are intact.
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