President's Budget is Bad News for Plans

On April 10, the Obama Administration released its budget for the 2014 fiscal year that begins on October 1, 2013.  The budget is not binding; Congress may deal with it as it wishes.  It is guaranteed to be controversial because the President is proposing entitlement cuts and new taxes – something to upset both Democrats and Republicans.  The budget contains the following provisions that affect retirement plan issues.  You can access the Treasuries “green book” here for a more detailed discussion.  

• The section 404(k) deduction for large ESOP plans is repealed.  Currently, C corporations are allowed a deduction for dividends paid with respect to employer stock held in an ESOP.  The budget proposes to repeal the deduction for C Corporations with annual receipts in excess of $5 million.  The Administration noted that the deduction “creates an additional incentive for employers to encourage investment in employer stock.”  Clearly, they think this is not a desirable activity.
• The mandatory automatic IRA is back.  Once again, the budget includes a mandate for employers who do not offer a retirement plan to provide an automatic enrollment IRA to their employees.  PSCA does not support any mandates to provide employee benefits.  The provision also increases the start-up credit for small employers that adopt a retirement plan.
• Retirement contributions capped at the 28 percent bracket.  The deferral for contributions to defined contribution plans and IRAs will be capped at the 28 percent tax bracket.  Filers in higher brackets will have their tax benefit reduced.  The provision also applies to employer-provided health care, interest on municipal bonds, HSAs and Acher MSAs, and some minor personal deductions.  A provision, added this year, allows that an affected taxpayer’s basis will be adjusted for retirement plan contributions.  This should address any double tax issues, but it will require additional recordkeeping.
• Non-spouse beneficiaries will have to take inherited distributions over five years.  This response to the “stretch IRA” is new in the budget, but it was raised by Senate Democrats last year.  Currently, and generally, if a participant or IRA owner dies, non-spouse beneficiaries are required to distribute the inherited assets over their life expectancy.  If they die, distributions are made over a subsequent beneficiary’s life expectancy.  The budget provides non-spouse beneficiaries will have to distribute inhered assets over no more than five years.  Exceptions apply to beneficiaries who are disabled, chronically ill, minor children, and an individual who in not more than 10 years younger than the deceased participant or IRA owner.  
• A new overall limit on retirement benefits.  This is a new and controversial provision.  The Administration has determined that current law “does not adequately limit the extent to which a taxpayer can accumulate amounts in a tax-favored arrangement.”  It has concluded that the single DB plan benefit limit, currently $205,000, is enough for anybody.  Their proposal creates an overall aggregate individual limit for section, 401, 403(b), and 457(b) plans that is equivalent to a $205,000 annuity – approximately $3 million.  The limitation will be calculated annually based on the section 415 DB plan limit and current annuity conversion rates.  Plan sponsors and IRA providers will have to report an individual’s account balance (I’m not sure to whom).  If the limit is reached, no further contributions or accruals will be permitted.  Besides being horrible policy, the administration of this provision should be an absolute nightmare.
• Required minimum distribution relief for small balances.  The RMD rules will not apply to individuals with an aggregate value of IRA and qualified retirement plan assets that do not exceed $75,000.  Active DB plan annuity payouts are excluded in the calculation.  PSCA thinks the RMD rules should be repealed, and this is a step in the right direction.  However, very few folks are likely to benefit.
• Improved rollovers for non-spouse beneficiaries.  Non-spouse beneficiaries who inherit plan assets or an IRA may rollover assets in a direct trustee-to-trustee rollover, but not a 60-day rollover.  The provision will permit 60-day rollovers.  
• Eliminate deflationary adjustments.  Many tax code provisions, including various retirement plan provisions, are indexed to inflation.  This provision clarifies that provisions and limits will not be deceased if price levels fall.  
• The chained CPI.  The administration is proposing a new chained CPI for all elements of law subject to indexing, including entitlements and tax law.  This lower index will retard increases in plan limits compared to the current index.

A President’s budget rarely is enacted in its entirety.  Rest assured that PSCA will aggressively oppose many of these provisions, particularly the ESOP provision, the 28 percent rule, and the aggregate individual limit.