Tax-deferred retirement accounts were created under a law passed by Congress in 1974. They strike a bargain between taxpayers and the Treasury: money in the accounts grows tax-free, but taxable withdrawals must be taken yearly after age 70 and-a-half.
Both sides win. Roughly half of all Americans have gotten a jump on financial security and now hold trillions in retirement savings. On its part, the Treasury gets an annual influx and is nearing demographic gold. The first baby boomers reach required distribution age in 2016, and a mother lode of retirement taxes should start streaming in.
Congress, though, has proven more than willing to help the affluent slip away from the tax payback. Two examples are the late-December 2010 renewal of a 2006 Bush tax break and a one-year suspension of minimum required distributions.
The starkest instance – and the most costly for the Treasury – stemmed from the financial meltdown. With portfolios plummeting, Congress rushed to freeze mandatory withdrawals for 2009. Only the haves stood to gain. Anyone who actually needed the distribution had to take it and pay taxes; the haves took a pass and saved thousands.
The stock market recovered and the suspension was allowed to lapse. Nobody should expect an encore, but the precedent has been set.
The lame-duck Congress passed, among other measures, an extension of the Bush tax cuts for the wealthiest two percent of Americans. Along with it, fitting right in, came a one-year renewal of the IRA charitable deduction.
Holders of individual retirement accounts (IRAs) can direct up to $100,000 of their annual required distribution to charities. No federal or state taxes are paid. Because the money doesn't count toward income on tax returns, high-income filers could avert hikes in Medicare premiums. According to one estate attorney, the bill is “good for about ten different reasons.” They're all about avoiding taxes.
What we have here is a siphoning away of public revenue to private charity. Money may go to good causes, but the transfer violates the payback half of the retirement bargain. In effect, the money is being stolen from the US Treasury (and from every state that has an income tax).
Donors have their hearts in the right place and the law behind them. Charities are thrilled. The thieves are in Congress, always ready to jigger the tax code on behalf of the well-off.
Withdrawal formulas also stiff the Treasury by putting a tight lid on annual increases. While the formulas apply to everybody, they heavily favor those in no need and no hurry. So-called stretch IRAs, an estate planning tool, can string out distributions – get ready now – into the next century.
Brokerage houses distort the tax payback in their own way. They're making billions on retirement accounts, but they continually bash required distributions. A Fidelity advisory, for example, told clients that at 70 and-a-half, they're “required to start raiding” the accounts.
Raiding? Not exactly. Minimum distributions mean it's time to pay back Uncle Sam for decades of tax deferral. Even after federal and state taxes, affluent Americans over 70 and-a-half are likely looking at annual payouts in the healthy five figures. Whatever the number, it got there with a long, tax-free ride.
How about a little gratitude? And instead of robbing Uncle Sam, let's have sensible distribution rules from Congress.