If plans to cut IRAs succeed, the middle class will be collateral damage

Senate Finance Committee Chair Ron Wyden (D-Ore.) and House Ways and Means chair Richard Neal (D-Mass.) are working on legislation to limit the size of Individual Retirement Accounts (IRAs) over $5 million. Media accounts have reported that this effort could be part of a search for funding for the $3.5 trillion “human infrastructure” legislation. The move is also, per Wyden, a direct reaction to investigative reports by ProPublica, based on leaked individual tax returns revealing the highly fortunate capital appreciation of newly issued stock held in the Roth IRA of one particular billionaire.   

Limiting billion dollar IRAs, despite the policy’s visceral appeal, will not produce that much revenue on a sustained basis, because there are so few. So the outrage is now being transferred to more numerous IRAs holding millions, as shown in statistics on IRAs requested from the Joint Committee on Taxation. What the chorus demanding reform does not realize is that commonplace government pensions — which are allowed by law with no proposals for change, and largely not controversial — are easily worth those sorts of amounts. 

Consider, for example, a 55-year-old police chief of a large city earning $290,000 a year; let’s assume he has 32 years less three months of service, and has been chief for three years. He decides to retire now 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 there is no reduction in his payout for early retirement. With a 2.5 percent annual accrual rate (again, not uncommon), his annual benefit will be $230,000, at the current IRS benefit limit on defined benefit pension amounts.  

As is typical in state and local government employee pension plans, the benefit gets a cost of living adjustment tied to inflation. Moreover, the benefits continue for the rest of his life and then continue at two-thirds the amount for the life of his wife, who, let’s say, is 52 years old. 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, by my calculation, such a pension is worth $10 million.  Where is the outrage on this amount?  It is rich for public service, but these senior positions entail a career of difficult work, and, so far, the resulting pensions are unremarked upon. 

Let us further consider the fairness and workability of possible limits on IRAs. Unlike pension benefits, the account values of IRAs are not fixed or guaranteed; holders take risks in the hope that the values of the underlying investments will increase, perhaps significantly.  So, if the federal government essentially limits the amount of IRAs held by an individual to $5 million, the amount proposed by Wyden, by forcing distributions and limiting contributions at that trigger point, considerable damage will be done to the proper retirement planning of tens of thousands of higher-income, but not wealthy, workers and retirees.  In such a punitive retirement tax regime, any reasonable person would avoid risky investments entirely, considerably before the $5 million limit was reached.  

The consequence would be the complete absence of stock and bond investments in large size retirement accounts. This would undoubtedly negatively impact the markets, given the aggregate size of these accounts, and hence, by extension, the retirement prospects of many more middle-income households not directly affected by the new rule.

One should not expect that these measures and consequences would be limited to IRAs.  Other retirement accounts, like 401(k)s and 403(b)s, sponsored by employers, would be drawn into the legislation and reaction because the system is designed for funds to be moved from one type of account to another, at various stages of the life cycle, for efficiency and good management. So, the statistics being relied upon for the number of and amount held in large IRAs are certainly underrepresenting the impact (probably by more than half, given aggregate amounts) by ignoring other retirement accounts.  

If there are abuses, there are targeted solutions to them. But efficient retirement planning and sensible investment strategies would be punished in the proposed plan and it is unfair to those working in the private sector without large pensions. 

This frenzied overreaching policymaking is responding to breathless reporting of an instance of outrage (which is ultimately unclear whether justified), and the need to raise revenues to finance massive new social spending programs of doubtful utility. Such a combination does not produce a decent retirement policy and will cause more harm than good.  

Mark Warshawsky is a retirement policy expert with American Enterprise Institute.