I have to confess that I wasn’t terribly impressed with the SECURE Act as a way to help Americans save for retirement. Delaying the start date for required minimum distributions from 70 1/2 to 72 doesn’t, for me, seem to move the needle more than a few inches. Allowing 401(k) automatic increases to go up to 15% of a worker’s salary from the current 10%? Yawn. Allowing small employers to create joint 401(k) plans? Don’t we already have SIMPLE plans? I like the idea of allowing individuals to continue to contribute to an IRA after age 70 1/2, but is that really going to solve America’s alleged retirement crisis?
I was thinking along these lines when I ran into Ed Slott, who happens to be the acknowledged guru on IRA issues, at the ENGAGE conference in Las Vegas. He agreed with my assessment, so naturally I asked him what he would do if we were to somehow elect him to Congress.
I think Slott’s proposed legislation would be far more valuable to Americans than anything Congress is currently producing.
Slott would start by eliminating the income limits on Roth contributions. Currently your allowed contribution is reduced when your income is above $122,000 if you’re single, or $193,000 for joint taxpayers. Roth contributions are phased out altogether for people earning more than $137,000 or couples above $203,000. “Why should people have to figure out their income before making contributions?” Slott asked. “It’s completely unnecessary complexity.”
Yes, there is what is called a “backdoor Roth,” where somebody above those limits contributes to a traditional IRA and then immediately converts it to a Roth—paying taxes, of course, on the conversion. But if you can do this anyway, why have income limits in the first place?
What a great start! What else? Slott’s proposed legislation would eliminate required minimum distributions (RMDs) altogether. “That would eliminate so much confusion for seniors,” he said, “where people have to calculate the thing, and if somebody makes a mistake there’s the 50% penalty. And more importantly,” Slott continued, “it gives people control. IRA accounts are intended for lifetime retirement, so let people use them for their intended purpose. People are free to take as much or as little out of their accounts, and the government will get their money in the end.”
But what if people create monster IRAs that they never use, and then use stretch IRAs as an estate planning tool? Slott would reluctantly embrace a provision of the SECURE Act where non-spousal IRA heirs would have to take the money out within ten years. “I think that’s fair; IRAs were never intended as an estate planning tool,” he said. “They’re intended to provide for peoples’ retirement.”
Slott would also eliminate the 10% penalty on premature IRA distributions—that is, before age 59 1/2. “Roth contributions can be withdrawn any time for any reason, tax-free, penalty-free,” he said. “It should be the same with your IRAs. You would pay taxes on it, of course, and it might hurt your retirement down the road. But people have to take responsibility, knowing if they grab it now, they’ll have less later.”
What else? Slott made up a new term: QMDs—Qualified Medical Distributions. “It’s based on QCDs—Qualified Charitable Distributions,” he said, “where you take it right from the IRA to the charity, and it doesn’t have to be included in income.”
What’s the benefit of a QMD? “As a tax practitioner, I look at a lot of tax returns,” said Slott. “I see a lot of people who have IRAs, and that is the only money they have left to pay the doctors and hospitals and nursing homes.”
The problem, however, is that if they take out money from the IRA, it adds to their income, which raises the threshold at which they can start deducting medical expenses. The more you take out, the higher your income, the higher the deduction threshold, and the wheel keeps spinning. Does that make any economic sense? “Let the money come out as a QMD, direct from your IRA to the doctor or the hospital and exclude it from income,” said Slott. “You’re not beating anybody out of anything. You’re actually using an IRA for what it’s supposed to be used for. Unfortunately,” he added, “medical bills are part of the retirement expense for all of us.”
Slott would also eliminate the once-per-year rollover rule, which applies in aggregate to all of a client’s IRAs and Roths. Currently, you are limited to one 60-day rollover per year, from just one of your accounts, where you receive the funds from one IRA and roll it over to another. If you do this for multiple IRAs inside that one-year window, the funds are considered distributed and may be taxable and subject to penalty. Of course, you can do as many direct trustee-to-trustee transfers as you wish, but Slott says we should eliminate this complexity altogether. “People don’t understand the rule. They do several rollovers and suddenly they lose their IRA,” said Slott. “Go back to the old rule where you can do once per year from each account.”
Finally, Slott would harmonize the rules for traditional and Roth IRAs when it comes to how to tax contributions that were not deductible. Today, if an IRA has non-deductible contributions in the portfolio, when you take money out, you have to calculate based on the pro-rata rules—basically, what percentage of the total represents non-deductible contributions that don’t have to be taxed. You report this on Form 8606.
“The business of doing a calculation every time the balance changes is burdensome,” said Slott. “Most people don’t understand it. Instead of pro rata,” he said, “I would do it just like the Roth IRAs. The basis comes out first, and then the taxable part. You do the same thing with IRAs, the same rules, and make it easier for people.”
What do you think? Could we support Slott’s proposed legislation?
And maybe bigger picture, shouldn’t the profession be creatively proposing tax laws that we think would improve American society?