NEW YORK (MainStreet) — The U.S. budget process is political posturing at its finest. The President submits a budget – just the first step in a long procedure of cussing and discussing. Many ideas are floated; many are discarded. And because saving for retirement is such a major issue for most Americans, it's important to keep an eye on the budget process for signs that the government may be messing with your money.
This year, the President has floated several ideas that could impact your retirement nest egg.
One legal loophole that high-income earners often use to set aside some tax-free retirement income is in danger of being eliminated. Jamie Hopkins, an associate professor of taxation at the American College of Financial Services, an accredited educational institution for financial professionals, believes it's likely the government will shut down the "back door" IRA, a strategy that allows high-income earners to sidestep the Roth income restrictions by contributing to a traditional IRA and then -- because there is no conversion limit -- transferring the assets to a Roth.
"Trying to close the back door IRA, as an enforcement issue, makes a lot of sense," Hopkins says. "We have rules in place that try to keep high-income individuals from making direct contributions to a Roth IRA." Even if the President and Congress don't bar the back door, the IRS might, Hopkins says.
Roth IRAs have become a regular target in government budget battles – perhaps in politicians' minds it's a tax break almost too good to be true. The administration is also proposing to port over the withdrawal mandates of traditional IRAs to Roths -- the so-called "required minimum distribution" that triggers for account holders near age 71.
"Taking away the flexibility that a Roth IRA has, I think that would be really detrimental to a lot of people," Hopkins says. "Having one account that grows on a tax-preferential basis, that we have flexibility with is really important for retirement planning. A lot of times people use that Roth IRA as the backup account for retirement, because they're not being forced to take money out when they're 71-72; they can hold on to it until they're 85. They know it's going to keep growing and that they're not going to have to worry about changing tax rates -- it provides a lot of certainty. A lot of people use that as a kind of emergency fund because [they] know it's not going to be self-depleting over time."
Some financial advisors worry that political meddling may one day undo the Roth's tax advantage altogether. Hopkins, however, doesn't think that's likely. "I no longer believe that we're going to see a big push to take away the tax preferential nature of a Roth IRA because of its use in the federal myRA program."
And then there's the matter of limiting just how much Americans can set aside for retirement – the savings cap.
"I am not a fan of the $3.4 million cap," Hopkins says. While the number may seem completely random, he says the limit is derived from the lump sum required to generate a $210,000 annual income from a life annuity beginning at age 65. And while that may seem a significant income, Hopkins maintains it would require a serious lifestyle adjustment for someone who is accustomed to earning, say $400,000 annually prior to retirement.
"It shouldn't be the goal of the government or of planners to make sure that only certain people can maintain their quality of life in retirement," Hopkins says. "Our goal here should be to have everyone with a dignified retirement where we don't have to cut back our standard of living significantly in retirement."
The mega-million dollar Romney-sized IRAs might be another matter, but "$3.4 million isn't as much money as it used to be," Hopkins adds, especially considering the lump sum would likely only cover the cost of a life annuity that doesn't adjust for inflation.
Some of the President's budget initiatives are likely to be instituted, because they don't require Congressional approval. One being the stipulation that ensures same-sex couples receive Social Security benefits equal to heterosexual spouses. "That one will probably just be implemented," Hopkins says.
And $6.5 million is earmarked to help states implement automatic IRAs – a default savings account for workers without access to a company-sponsored retirement plan. The amount allocated may vary, but Hopkins believes some funding will go to the effort. Illinois is already moving ahead on such accounts; another 30 states are looking into it.
"An automatic IRA doesn't cost the government a whole lot, it doesn't cost the employer a whole lot," Hopkins says. And that means it's likely to win favor among budget-minded politicians.
-- Hal M. Bundrick is a Certified Financial Planner and contributor to MainStreet. Follow him on Twitter: @HalMBundrick