For almost 40 years, Uncle Sam has generously subsidized retirement accounts (regular IRAs, 401ks, 403bs and the like) for our golden years. Annual contributions are commonly tax-free.
The gains that accumulate on these investments are tax-deferred, usually for decades. Only on the back end do taxes enter the picture. They’re due and payable when withdrawals begin. They can start when you turn 59 1/2 if desired. Otherwise, they must begin at age 70 1/2 and are mandatory each year from then on.
The time for mandatory tax payback is exactly when the affluent — with help from both sides of the aisle — begin to welsh on their end of the retirement bargain. New schemes are dreamt up, legislation enacted, and rules adopted to avoid, delay, and minimize taxes on withdrawals. Ironically, it’s the affluent who easily benefit the most from retirement tax breaks. The Treasury foregoes $52 billion a year for high-contribution 401(k) accounts alone, making them the third-largest tax break in America.
Let’s look at some of the ways that Uncle Sam’s generosity has been repaid by outright welshing and systematic nickel-and-diming. Then let’s adopt John McCain’s 2008 campaign mantra and put “Country First” to see how retirement taxes could help cut our record federal deficit. Tens of millions of baby boomers will begin to hit the mandatory retirement account withdrawal age in 2016. There’s enough time for Congress to make new rules that more fairly enforce the tax payback portion of the retirement account bargain.
A bipartisan Congress twice crafted laws specifically inviting well-heeled taxpayers to renege on the tax payback. For 2009, in a move that could only benefit the affluent, lawmakers suspended mandatory distributions. Any taxpayer who actually needed the distribution had no choice but to take it and pay taxes. Those who didn’t need the money took a pass and saved thousands of dollars, which enlarged the burgeoning federal deficit. Earlier, in another deficit-hiking move, Congress allowed up to $100,000 per year in retirement distributions to be signed over to private charities — another move that denied the Treasury the taxes it had coming, and state and city coffers as well.
Both laws rested on ultra-flimsy rationales, and both have lapsed. There’s plenty more that still needs fixing, starting with the mandatory distribution age itself. Who benefits, after all, from a tax payback that doesn’t even have to begin until they’re more than 70 years old? Surely not Uncle Sam. Those who count on retirement accounts to help them get along don’t benefit either. Those folks are drawing down money from their accounts well before that. The only real beneficiaries are those who simply don’t need the money — and their heirs.
The same can be said for the withdrawal formulas, which start out low and creep up ever so slowly. The formula that applies to most people calls for a starting minimum required distribution of under 3.7 percent. Twenty-five years later, at age 95, the required distribution is just 11.6 percent. While the formulas apply to all taxpayers, the benefits flow entirely to those in no need and no hurry.
Now let’s apply McCain’s “Country First” to retirement taxes. First, let’s draw down the mandatory distribution age from 70 and six months to 65: when it’s Medicare time, it’s also time to start paying back Uncle Sam for those retirement tax breaks. Second, let’s increase the minimum withdrawal percentages to bring them more in line with actual life expectancies. Third, let’s forbid so-called “stretch IRAs.” These are multi-generational transfers, now permitted, which can string out distributions (and the taxes on those distributions) into the next century. Multi-generational transfers are fine, but America deserves its full cut first.
It’s the least the affluent can do to pay back our generous uncle.