Putting a Cap on Retirement Accounts?

by Michael on Apr 12, 2013 · 3 comments

Capping Your Retirement Accounts?

One of the big pieces of news out of President Obama’s budget proposal was a proposed cap on retirement accounts.

You may have heard rumblings about this in the form of a possible $3M limit on balances across all of your retirement accounts.

Today I want to shed a bit more light on this. As always, the full story is a bit more complex than that portrayed by the media. What follows is based on official guidance from the Treasury Department.

For background, there is currently a limit on the maximum benefit that can be paid under a qualified defined benefit plan (think pensions) of $205k/year. This amount is subject to annual cost-of-living increases.

For defined contribution plans — think 401(k) plans and the like — you are limited in how much you can contribute each year. The contribution limits are likewise subject to annual cost-of-living increases.

The same goes for IRAs. You are once again limited in how much you can contribute. But there is no limit on how large these accounts can grow.

The President’s proposal is to essentially level the playing field between defined benefit and defined contribution plans by limiting the total amount that can be accrued within tax-advantaged retirement accounts to no more than the amount that would generate $205k in annual income.

Currently, for someone who is 62, that number has been pegged at $3.4M, which works out to an annual withdrawal rate of 6% (i.e., $205k/$3.4M = 6.03%). The cap would be re-estimated at the end of each year and would apply to contributions or accruals for the next year.

What if you save too much?

Importantly, there would be no requirement to liquidate larger balances:

“If a taxpayer reached the maximum permitted accumulation, no further contributions or accruals would be permitted, but the taxpayer’s account balance could continue to grow with investment earnings and gains.”


“If a taxpayer’s investment return for a year was less than the rate of return built into the actuarial equivalence calculation (so that the updated calculation of the equivalent annuity is less than the maximum annuity for a tax-qualified defined benefit plan), there would be room to make additional contributions.”


“When the maximum defined benefit level increases as a result of the cost-of-living adjustment, the maximum permitted accumulation will automatically increase as well. This also could allow a resumption of contributions for a taxpayer who previously was subject to a suspension of contributions by reason of the overall limitation.”

Pretty straightforward. You may or may not agree with the idea of capping tax-advantaged retirement accounts, but the proposal isn’t nearly as aggressive as what has been portrayed in the media.

Indeed, there has been much fear-mongering about people being forced to liquidate their accounts if they’re over the limit, and so forth. But that’s not the case.

Note: In an earlier version of this article, I expressed concern over an apparent requirement to annuitize in retirement. Upon re-reading the relevant text from the Treasury, I believe that I mis-interepreted this point. It appears that the conversions that they referenced (in rather obtuse terms) were purely theoretical exercises to estimate and adjust the overall balance limits.

My thoughts

I don’t have a big problem with the idea of capping these accounts, especially with a reasonably high cap. If you exceed the cap, no problem. You don’t have to liquidate, and you’re free to continue investing — you’ll just have to do it in a taxable account.

My biggest concern relates to how the cap is estimated. As I noted above, they’re assuming a slightly better than 6% withdrawal rate. That’s extremely high, especially given currently low risk-free rates of return.

By assuming that 6% is a sustainable withdrawal rate, they’re effectively depressing the cap. With a more conservative assumption of 4% (or less), the cap would have to be substantially higher to produce the same amount of income.

And going forward, it would be easy to play with the assumptions to manipulate the cap. For example, by increasing the (assumed) withdrawal rates when interest rates eventually rise, one could easily shrink the cap.

It also important to remember that people can’t hide money in their retirement accounts forever. Yes, this would increase near-term revenue, but that money is eventually coming out one way or another.

While the rules for inherited IRAs allow a spouse to treat it as their own, non-spousal beneficiaries have to start taking required minimum distributions the year after the death of the account owner.

So, no matter how much you manage to stash away, that money will eventually have to be withdrawn and subjected to taxation.

Anyway… It’s also important to remember that the President doesn’t make laws. That’s up to Congress. If this stuff ever makes it through the legislative process, it will likely look quite different on the other side.

Source: Treasury.gov (see pages 165-167)

1 Harry April 13, 2013 at 1:12 am

I didn’t read it as forced annuitization. “would be converted” refers to for the purpose of *calculating* whether your account balance has reached the cap. Every retirement account provider takes your balance and calculates how much annuity (starting at age 62) the money can buy. You add up all these annuity-equivalent values. If the total reached $205k (or its inflation adjusted amount for that year), you are capped. If you are 42, your balance cap would be lower, because the money is assumed to grow another 20 years before it buys the annuity.

2 Michael April 13, 2013 at 10:25 am

Harry: Upon re-reading these passages in their full context, I think that you’re right. I have modified the text (and inserted a note) accordingly. The dangers of reading/writing while sleep deprived on the road… 🙂

3 Evan April 15, 2013 at 1:26 pm

It is just another short sighted move to appease those that would like to bash the upper echelon of society.

Money has to flow somewhere and at that level of wealth we are talking about a TON of money. Maybe it creates a (bigger) muni bond bubble since that income would be effectively federal tax free forever…maybe money flows into deferred insurance based products…maybe the money is then gifted and the gov’t won’t see it for 30, 40 or 70 years? No one knows the unintended consequences but those are a few off the top of my head.

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