United States: White House Budget Proposal Includes Many Retirement-Related Provisions

On February 2, 2015, the White House released its Fiscal Year 2016 Budget, which includes a number of tax code changes targeting retirement savings. If enacted as presented, the proposals would have a significant effect on current retirement-related tax incentives. The stated intention of the suggested changes is to simplify the Internal Revenue Code and use the resulting savings to pay for other reforms of the tax code.

This On the Subject provides a summary of the retirement-related proposals (for more detailed explanations of all of the budget proposals, see the U.S. Department of the Treasury's Green Book).

Tax Reform for Families and Individuals

Provide for Mandatory IRA Auto-Enrollment for Certain Small Businesses and Related Tax Credits

The proposal would require an employer that has been in business for at least two years and has more than 10 employees to offer an automatic IRA option to its employees if it doesn't already offer another type of employer-sponsored retirement plan (e.g., 401(k) plan). Employers that already sponsor a qualified retirement plan would not be required to offer the automatic IRA option. However, if any portion of the employer's workforce is excluded from participation in a plan, the employer would be required to provide the automatic IRA option to those excluded employees. The proposal would allow for certain employees to be excluded from the automatic IRA; the exclusions in the proposal are similar to the exclusions permitted for qualified plans.

Under the proposal, any employee who did not provide an election would automatically be enrolled at a default rate of 3 percent. Employees could choose a lower or higher contribution rate up to the IRA dollar limits or choose to opt out of the IRA program. Employees could select either a traditional IRA or a Roth IRA, with Roth being the default.

The proposal would give employers that have no more than 100 employees and offer an automatic IRA arrangement (or another plan with an automatic enrollment feature) a temporary non-refundable tax credit and would provide a tax credit for the "start-up costs" of the automatic IRA arrangement (or other plan).

This proposal would become effective after December 31, 2016.

Expand Penalty-Free Withdrawal Exception for Long-Term Unemployed Individuals

The proposal would expand the exception from the 10 percent early withdrawal penalty tax to cover distributions from an IRA or defined contribution plan to long-term unemployed individuals. An individual would be eligible for this exception if he or she has been unemployed for more than 26 weeks and has received unemployment compensation for that period (or, if less, for the maximum period for which unemployment compensation is available under applicable state law) and meets certain other requirements. Eligible distributions would be limited to a maximum of $50,000 per year during each of the two years when distributions are permitted under this exception, for a total of $100,000 with respect to any single period of long-term unemployment.

This proposal would apply to eligible distributions made after December 31, 2015.

Require 401(k) Plans to Allow Long-Term Part-Time Workers to Participate

The proposal would require section 401(k) plans to allow employees who work at least 500 hours per year with the employer for three or more consecutive years to make salary reduction contributions. Employers would not be required to make matching or nonelective contributions for these employees. These part-time employees would also be credited with a year of service for purposes of vesting in any employer contributions for each year in which they complete 500 or more hours of service. Employers would receive nondiscrimination testing relief with respect to these newly covered employees (similar to that provided under existing law for plans covering otherwise excludable employees), and could exclude them from top-heavy vesting and top-heavy benefit requirements.

This proposal would apply to plan years beginning after December 31, 2015.

Facilitate Annuity Portability

Under current law, a 401(k) plan generally cannot distribute amounts attributable to a participant's salary reduction contributions before (1) the employee's death, disability, severance from employment, hardship or attainment of age 59½, or (2) termination of the plan.

The proposal would permit participants under a plan that initially offered an annuity investment option, but later eliminated that option, to effect a direct rollover of the amounts attributable to that annuity investment to an IRA or other retirement plan without regard to whether such a distribution would otherwise be prohibited under the 401(k) distribution rules.

The proposal would be effective for plan years beginning after December 31, 2015.

Simplify Minimum Required Distribution Rules

Required Minimum Distributions (RMDs) for most participants must commence in the year that immediately follows the year the participant reaches age 70½ or, if later, the year of retirement. The proposal would exempt an individual from the RMD requirements if the aggregate value of the individual's IRA and tax-favored retirement plan accumulations does not exceed $100,000 (indexed for inflation after 2016) on a specific measurement date. For this purpose, benefits under defined benefit pension plans that have commenced would be excluded in determining the dollar amount of the accumulations.

Under current law, no RMDs are required from Roth IRAs prior to death. Importantly, the proposal treats Roth IRAs in the same manner as all other tax-favored retirement accounts, requiring RMDs to commence at age 70½. In addition, individuals would not be permitted to make additional contributions to Roth IRAs after they reach age 70½.

The proposal would be effective for taxpayers attaining age 70½ on or after December 31, 2015, and for taxpayers who die on or after December 31, 2015, before attaining age 70½. This proposal will be of particular concern to non-grandfathered taxpayers who have made rollovers to Roth IRAs in part to avoid pre-death RMDs.

Allow Inherited Plan and IRA Balances to Be Rolled Over Within 60 Days

Generally, assets can be moved from a qualified retirement plan or an IRA into an IRA or another qualified retirement plan without adverse tax consequences. Under current law, a surviving non-spouse does not have the same options as a surviving spouse when moving assets from one arrangement to another. To eliminate these differences, the proposal would allow a surviving non-spouse beneficiary under a qualified retirement plan or IRA to move inherited plan or IRA assets to a non-spousal inherited IRA through a 60-day rollover.

The proposal would be effective for distributions made after December 31, 2015.

Loophole Closures

Require a Five-Year Distribution for Non-Spouse Beneficiaries of Retirement Plans and IRAs

When a participant or IRA owner dies before distributions have begun, the entire remaining benefit generally must be distributed to a non-spouse beneficiary either within five years of the participant's death or over the life expectancy of the beneficiary, with payments starting no later than one year following the participant's death. In cases where the beneficiary is much younger than the participant or IRA owner, the current rules permit the beneficiary to "stretch" the receipt of distributions over many years and to benefit from the tax-favored accumulation of earnings over long periods of time.

Under the proposal, non-spouse beneficiaries would generally be required to take distributions over no more than five years. This mandatory five-year distribution requirement would not apply to any beneficiary who is not more than 10 years younger than the participant or IRA owner, a minor child, disabled or chronically ill. For these beneficiaries, distributions would be allowed over the life or life expectancy of the beneficiary beginning in the year following the year of the death of the participant or owner. In the case of a minor child, the account would need to be fully distributed no later than five years after the child reaches the age of majority.

The proposal would be effective for distributions with respect to participants or IRA owners who die after December 31, 2015. An exception applies for participants whose benefits are determined under a binding annuity contract in effect on the date of enactment.

Limit the Total Accrual of Tax-Favored Retirement Benefits

The proposal would prevent any new contributions to a defined contribution plan or IRA, or benefit accruals under a defined benefit plan, if such contributions or benefit accruals, when combined with the existing accumulation, would exceed the amount necessary to provide the maximum annuity permitted for a tax-qualified defined benefit plan payable in the form of a 100 percent joint and survivor annuity commencing at age 62. For 2015, this amount is $210,000, which is adjusted annually for cost of living increases. Once an individual reached the maximum permitted accumulation, no further contributions or accruals would be permitted. However, the retirement accumulation could increase with investment earnings and gains.

This proposal is sometimes described as the "$3.4 million cap on retirement savings," which is based on the current $210,000 annuity limit and, more importantly, current interest rates. The proposal would limit the retirement accumulation to an amount large enough to provide the maximum annuity benefit at age 62. In today's low interest environment, this equates to a maximum allowable accumulation of $3.4 million at age 62. However, rising interest rates will reduce the maximum permitted accumulation. Based on the historical interest rates that the government uses for annuity calculations, the limit could be as low as $300,000 for a 35-year-old employee. A relatively young high-income earner could easily reach the maximum limit before turning 40 years old.

Contributions and/or accruals in excess of the applicable limitation would be treated in a manner similar to the treatment of excess 401(k) deferrals under current law. The excess amount would be currently includible in income unless withdrawn from the plan during a specified grace period. If not withdrawn, the excess amount would be subject to tax when distributed without any adjustment for basis.

The proposal would be effective with respect to contributions and accruals for taxable years beginning after December 31, 2015.

Limit Roth Conversions to Pre-Tax Dollars

Under the proposal, after-tax amounts held in an employer-sponsored retirement plan or a traditional IRA could not be converted to Roth amounts.

The proposal would apply to distributions occurring after December 31, 2015.

Eliminate the Deduction for Dividends on Stock of Publicly Traded Companies in ESOPs

The proposal would repeal the deduction for dividends paid with respect to employer stock held by an Employee Stock Ownership Program (ESOP) that is sponsored by a publicly traded corporation. Rules allowing for immediate payment of an applicable dividend would continue, as would rules permitting the use of an applicable dividend to repay a loan used to purchase the stock of the publicly traded corporation.

The proposal would apply to dividends and distributions that are paid after the date of enactment.

Repeal Exclusion of Net Unrealized Appreciation in Employer Securities

Net Unrealized Appreciation (NUA) is the excess of the market value of employer stock at the time of distribution over the cost or other basis of that stock to the trust. Under current law, NUA that is received as part of a lump-sum distribution from a tax-qualified retirement plan is excluded from gross income in the year of the distribution. NUA is generally taxed as a capital gain at the time the employer stock is ultimately sold by the recipient.

The proposal repeals this exclusion for NUA. The stated reason is that the exclusion encourages a concentrated investment in employer stock, which subjects retirement benefits to increased risk (potentially the same risk that could affect participants' job security) without necessarily offering a commensurate return.

The proposal would apply to distributions made after December 31, 2015. Importantly, participants who have attained age 50 on or before December 31, 2015, would not be affected by the proposal.

Reforms to Capital Gains Taxation, Upper-Income Tax Benefits and Taxation of Financial Institutions

Reduce the Value of Certain Tax Expenditures – 28 Percent Maximum Tax Benefit

The proposal effectively creates a 28 percent limit on the tax benefit for salary reduction contributions to 401(k) plans and IRA contributions. For taxpayers in the 33 percent, 35 percent or 39.6 percent tax brackets, this limitation would reduce the value of the exclusions and deductions to 28 percent of the contribution. Other income exclusions limited by this provision include tax-exempt state and local bond interest and employer-sponsored health insurance paid for by employers or employees' salary reduction dollars.

If the exclusion for contributions to retirement plans and deduction for contributions to IRAs is limited by this proposal, then the taxpayer's basis (within his or her retirement account) is adjusted to reflect the additional tax imposed. The proposal provides no guidance as to how such a basis adjustment would be made. Presumably, the affected participants would be required to provide information to the plan administrator regarding their marginal tax rates.

The proposal would be effective for taxable years beginning after December 31, 2015.

Tax Gap Reduction and Reforms

Require Form W-2 Reporting for Employer Contributions to Defined Contribution Plans

This proposal would require employers to report on Form W-2 the total amounts contributed to a participant's account under a defined contribution plan. This additional information is intended to facilitate compliance with the annual limits on additions to defined contribution plans.

The proposal would be effective for information returns due for calendar years beginning after December 31, 2015.


The retirement-related budget proposals are not yet law and may never become law. It is possible, however, that certain of these proposals may be enacted by Congress to raise revenue to pay for additional reforms.

White House Budget Proposal Includes Many Retirement-Related Provisions

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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