Congressional Democrats, intent on passing bipartisan retirement legislation this year, are sidestepping their long-standing objection to providing tax breaks for more affluent Americans and are supporting an expansion of the ability to transfer wealth into tax-favored savings plans for heirs.
Proposals in Congress that would give taxpayers more time before having to take required minimum distributions from retirement accounts would help affluent Americans further accumulate and pass down wealth, tax experts say.
Under comprehensive retirement security bills that passed the House this spring and won a stamp of approval from the powerful Senate Finance Committee in June, wealthy taxpayers would get an additional three years of tax-free growth in their retirement plans before having to take required minimum distributions.
The House's Securing a Strong Retirement Act of 2022, known as H.R. 2954 or Secure 2.0, would increase the age for required distributions from 72 to 73 beginning next year and to 75 beginning in 2033. The Senate's Enhancing American Retirement Now Act, or EARN Act, would allow older Americans to delay taking distributions until age 75 beginning after 2031.
All taxpayers would be able to delay required minimum distributions, or RMDs, under the measures, even those of modest incomes that must work to support themselves in their golden years. But tax experts say more affluent retirees will likely use the extra time to accumulate wealth in their 401(k) plans and then transfer it into Roth IRAs that have no distribution requirements and fewer restrictions on inherited wealth.
RMDs set the minimum amount taxpayers must withdraw from their traditional individual retirement accounts, SIMPLE IRAs, SEP IRAs, or retirement plan accounts beginning at age 72 under the Setting Every Community Up for Retirement Enhancement Act that was approved as part of the fiscal 2020 omnibus spending law in December 2019. Roth IRAs don't require RMDs until after the owner dies, according to the IRS. Taxpayers who fail to take an RMD must pay the Internal Revenue Service an excess accumulation penalty of 50% of the required distribution.
Jeffrey Levine, chief planning officer for Buckingham Strategic Wealth, said the proposed expansion of the RMD rules is clearly aimed at helping the wealthy rather than the 80% of American seniors who, according to IRS statistics, take out more than the minimum distributions from their retirement plans to pay for food, housing, and other necessities.
The legislation will give wealthy seniors more time to convert their retirement savings at more tax-efficient rates, he said. Instead of being forced to take an RMD of $30,000 at age 75, they could take that amount out at 74 and pay the same amount of tax that would be due a year later. Instead of going into a brokerage account, that $30,000 could go into a Roth IRA, where all the future growth is now tax-free, he said.
"Their tax bill would be the same as it would have been had they been subject to required minimum distribution, but now all the future gross on that money would be tax-free," said Levine, a certified public accountant and certified financial planner. "So, there is a huge win for wealthy folks."
In addition, most individuals, including spouses and non-spouse beneficiaries, would get another 10 years of tax-free growth after inheriting a Roth IRA before they have to do anything, he said.
"So, let's say for argument's sake, you converted $100,000 in your life into a Roth before you die. Your heirs would inherit that $100,000. They could leave it alone for 10 years. It can easily double over that time; 7% for 10 years doubles the money," Levine said. "In 10 years, they take a check for $200,000, and they can go out and spend every dollar of that $200,000."
Asked about the potential for wealth accumulation, congressional lawmakers maintained that the proposed RMD changes were included in the bipartisan legislation to meet the trend of Americans who are working and living longer and need to earn more for their retirements.
Senate Finance Committee member Sheldon Whitehouse, D-R.I., said that he hadn't studied the RMD provision closely but that the overall legislation is "progressive." Even though the wealthy would benefit, working class Americans would also receive help saving for their retirements, he said.
"That's the idea," Whitehouse said, noting that the bill had to include provisions supported by GOP lawmakers to earn their votes.
Sen. Rob Portman, R-Ohio, another member of the Finance Committee, also said he wasn't familiar with the wealth planning strategies that would come from the legislation or overly concerned by them.
"I'm more concerned about the guy who wants to keep working up to age 75, who has to take out money for his retirement and pay taxes, or the woman who wants to keep working," Portman said. "That's what I'm concerned about."
Stefan Smith, a partner in BakerHostetler's tax practice group, said lawmakers want to encourage Americans to plan for retirement without leaving the doors to the U.S. Treasury wide open.
"RMDs address the balancing act between the public policies of incentivizing retirement savings while also limiting tax deferral," Smith told Law360.
"Congress doesn't want the tax deferral to last forever because the federal government is losing out on tax revenue during the years that employees save for retirement," he said. "RMDs ensure that retirees will ultimately receive distributions and pay taxes at some point."
According to a section-by-section summary of the EARN Act, the bill would also reduce the 50% tax penalty that applies if a taxpayer fails to receive a RMD from an IRA or tax-preferred retirement plan to 25%.
The rate would be further reduced to 10% if the minimum distribution was taken within a correction period, which would generally end no later than the end of the second tax year after the year that the distribution should have been made, according to the summary.
The bill would also make changes to Roth IRA distribution rules. Under present law, RMDs aren't required as long as the owner lives, unless that Roth is designated in an employer retirement plan. The Senate bill would eliminate the pre-death RMDs beginning after 2023.
The proposed changes to retirement plans come as Senate Democrats have been forced to pare back their plans to raise billions in taxes from wealthy corporations and individuals as part of President Joe Biden's agenda to expand subsidies for child care and renewable energy and pay for other domestic spending priorities.
Finance Committee Chair Ron Wyden, D-Ore., has maintained that Democrats are determined to provide economic security and tax fairness for working Americans, even as objections raised by Sen. Joe Manchin, D-W.Va., effectively eliminated any consideration of wealth taxes in the version of the Build Back Better Act headed for a Senate vote before the August recess.
"The argument that we need an economic system that gives everybody in America the chance to get ahead, and that means everybody needs to pay their fair share, is good policy, and also makes sense politically," Wyden recently told reporters in defense of Democrats' tax priorities.
Democrats' willingness to expand investment opportunities available to wealthy taxpayers stands in stark contrast to the ongoing need to build retirement savings for minorities and people of color, said Nari Rhee, director of the University of California, Berkeley's retirement security program. She said Democrats were obviously looking to generate GOP votes by including the RMD provision in the legislation, even though less affluent Americans need more help from Washington.
Racial inequities in the ownership of retirement assets persist, with Black people worse off than white, and Latinos the worst off, Rhee told House lawmakers last year as they were considering the Secure 2.0 legislation. Among households aged 25-64, approximately 63% of white households have a 401(k) or IRA, compared with 40% of Black households and 32% of Latino households.
Moreover, typical Black and Latino households with a retirement account have less than half the retirement savings of a typical white household, with the savings for those groups averaging $30,000, $34,000 and $69,000, respectively, she testified.
Wealthy families can tap into a broad portfolio of other assets, rather than working until age 75, she said, including home equity, nonretirement investments, and even income from rental properties.
Essentially, raising the age for RMDs is "increasing the tax shelter for them; this is not a policy that's actually going to improve the retirement security of American workers or retirees," Rhee said. "It's really an increased tax subsidy for the wealth of the richest families."
Low- and moderate-income Americans don't tend to hold on to money in their retirement plans very long after they stop working, she explained.
"The logic that the legislators are using is this idea that people are working anyway; we don't want to penalize them for working longer," Rhee said. "But, people are working because they don't have sufficient retirement assets."
Senate lawmakers plan to merge the EARN Act with a separate measure, S. 4353, known as the Retirement Improvement and Savings Enhancement to Supplement Healthy Investments for the Nest Egg, or RISE & SHINE Act, that was approved earlier in June by the Senate Health, Education, Labor, and Pensions Committee.
If that combined bill passes the Senate, the differences in the House and Senate versions of the legislation must be worked out in a conference. Like previous retirement legislation, the resulting bill could pass Congress in December as part of a year-end tax or budget bill.
Both the House and Senate retirement bills would have similar revenue impacts on the federal budget, according to estimates by the Joint Committee on Taxation. The EARN Act would increase revenues by $144 million over the next decade, while the Secure 2.0 bill would raise $93 million over the same period.
The bills have similar revenue offsets, but differences in the way the provisions are written result in different revenue estimates, according to the JCT reports.
The JCT estimates don't fully account for the cost of the legislation, according to the Committee for a Responsible Federal Budget, a D.C.-based think tank that watches the impact of federal legislation on budget deficits.
The group said increasing the RMD age to 75 would cost approximately $30 billion, rather than the roughly $4 billion estimated by the JCT. Other provisions in the legislation that increase the use of Roth IRAs would likely raise the amount of federal red ink even higher, the group said.
Rhee noted that low-income American workers would be helped by a much-needed expansion of the saver's credit in the retirement legislation, which she argued was a better use of federal tax revenues than boosting the fortunes of wealthy retirees.
"If you're going to be spending tax dollars for tax expenditures, more of the focus needs to be on supporting the retirement asset accumulation of lower-income families, especially families of color that don't have as much wealth," Rhee said. "That's really where the money should be going. We already have a lot of tax subsidies for rich people to basically keep and grow their money."
Copyright © 2022, Law360 Tax Authority. All Rights Reserved. Contents of this publication may not be reproduced without the express written consent of Law 360 Tax Authority and CBIZ. This publication is distributed with the understanding that CBIZ is not rendering legal, accounting or other professional advice. The reader is advised to contact a tax professional prior to taking any action based upon this information. CBIZ assumes no liability whatsoever in connection with the use of this information and assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect the information contained herein.
CBIZ MHM is the brand name for CBIZ MHM, LLC and other Financial Services subsidiaries of CBIZ, Inc. (NYSE: CBZ) that provide tax, financial advisory and consulting services to individuals, tax-exempt organizations and a wide range of publicly-traded and privately-held companies.