Senator Ron Wyden (D-Ore.) and House Ways and Means Committee Chair Richard Neal (D-Mass.) are working on legislation to limit the size of Individual Retirement Accounts (IRAs) that exceed $5 million. According to media reports, this effort could be part of a search for funding for the $3.5 trillion “human infrastructure” bill. According to Wyden, the move is also a direct response to ProPublica investigative reports based on leaked individual tax returns revealing the highly fortunate capital appreciation of newly issued stock held in a billionaire’s Roth IRA.
Despite the policy’s visceral appeal, limiting billion-dollar IRAs will not generate that much revenue on a sustained basis because there are so few of them. As a result, the outrage is now being transferred to a larger number of IRAs holding millions, as evidenced by IRA statistics requested from the Joint Committee on Taxation. What the reformers fail to recognize is that commonplace government pensions – which are allowed by law with no proposals for change and are largely uncontroversial – are easily worth those kinds of sums.
Consider a 55-year-old police chief in a large city earning $290,000 per year; assume he has 32 years of service less three months and has been chief for three years. He decides to retire at the full retirement age of his municipality’s pension plan (age 55 or 30 years of service are common full retirement provisions in many government plans), so his payout is not reduced for early retirement. At the current IRS benefit limit on defined benefit pension amounts, his annual benefit will be $230,000 with a 2.5 percent annual accrual rate (again, not uncommon).
The benefit is subject to a cost-of-living adjustment tied to inflation, as is customary in state and local government employee pension plans. Furthermore, the benefits continue for the rest of his life and then at two-thirds the amount for the rest of his wife’s life, assuming she is 52 years old. According to my calculations, such a pension is worth $10 million at current(negative)real interest rates in the Treasury Inflation Protected Securities market, on the 10-year bond, and using current mortality rates published by the IRS. Where is the outrage over this sum? It is wealthy for public service, but these senior positions entail a career of difficult work, and the resulting pensions have gone unnoticed thus far.
Let us take a closer look at the fairness and viability of potential IRA limits. Unlike pension benefits, IRA account values are not fixed or guaranteed; holders take risks in the hope that the underlying investments will increase in value, possibly significantly. So, if the federal government effectively limits the amount of IRAs held by an individual to $5 million, as proposed by Wyden, by forcing distributions and limiting contributions at that trigger point, tens of thousands of higher-income, but not wealthy, workers and retirees will be harmed. In such a punitive retirement tax regime, any reasonable person would avoid risky investments entirely, considerably before the $5 million limit was reached.
These measures and consequences should not be expected to be limited to IRAs. Other employer-sponsored retirement accounts, such as 401(k)s and 403(b), would be drawn into the legislation and reaction because the system is designed to allow funds to be transferred from one type of account to another at various stages of the life cycle for efficiency and good management. So, by ignoring other retirement accounts, the statistics relying on for the number and amount held in large IRAs are undoubtedly underrepresenting the impact (probably by more than half, given aggregate amounts).
If there are abuses, there are specific solutions. However, efficient retirement planning and prudent investment strategies would be penalized under the proposed plan, which is unfair to those working in the private sector who do not have large pensions.
This frenzy of overreaching policymaking is in response to breathless reporting of an outrage (which is ultimately unclear whether it was justified) and the need to raise revenues to finance massive new social spending programs of dubious utility. This combination does not result in a good retirement policy and will do more harm than good.