By Laura Saunders
Washington is taking a hard look at tax-sheltered retirement
accounts, plans, especially "supersize" ones worth millions of
dollars. Savers should consider what it could mean for them.
The U.S. Government Accountability Office, an arm of Congress,
recently released a report on individual retirement accounts,
requested by Senate Finance Committee Chairman Ron Wyden (D.,
Ore.). Its publication coincided with Senate hearings on retirement
savings held last month.
The GAO study addressed questions many people asked after
disclosures that former presidential candidate Mitt Romney had a
traditional IRA worth as much as $101 million and technology
entrepreneur Max Levchin put more than 13.3 million shares of Yelp
stock in a Roth IRA before the firm went public in 2012.
How many supersize IRAs are there? The GAO estimates more than
300 individuals or families have IRAs with balances greater than
$25 million, while more than 9,000 have IRAs worth more than $5
million. The GAO wasn't able to distinguish between regular and
Roth IRAs, given the data.
While both types of IRAs benefit from tax-free growth, there are
significant differences between them. Savers can often deduct
contributions to traditional IRAs or make tax-free rollovers of
401(k)-plan assets into them, while contributions and rollovers to
Roth IRAs must be made with after-tax dollars.
There also are important differences for withdrawals. Mr.
Romney, for example, must begin taking annual withdrawals from his
traditional IRA at age 70 1/2 , with the payouts taxable at
ordinary income rates up to about 40%. Withdrawals from Roth IRAs
such as Mr. Levchin's, however, are usually tax-free, and there are
no mandatory payouts for the owner.
How can IRAs grow so big? The GAO study said that to accumulate
$5 million in an IRA by making the highest allowed individual
contributions from 1975 to 2011, the assets would have needed to
generate an average annual return of 18%. (Over that period, the
study said, the average annual return of the S&P 500 was about
7%.)
The final version of the GAO report, due in a few weeks, will
address strategies investors use to supersize their IRAs. Such
moves include using account assets to buy nontraded stock or
partnership interests that could balloon in value once inside the
account, experts say.
For example, according to the company's most recent proxy, Mr.
Levchin's Roth IRA held 2.7 million shares of Yelp, which recently
traded at around $70 per share. The stock was worth much less
before the firm went public. Mr. Levchin didn't respond to requests
for comment.
The Internal Revenue Service also is interested in supersizing
strategies, as harsh penalties for "self-dealing" violations can
apply to investors who participate in businesses owned fully or in
part by their IRAs.
To shine light in dark corners, the agency is changing reporting
requirements for hard-to-value IRA assets.
Starting with the 2014 tax year, brokerage firms and other IRA
sponsors will be asked to report such assets on Form 5498. The form
asks the sponsors to detail the fair-market value for each of
several asset classes, including real estate, nontraded debt or
stock, or an interest in a limited-liability company, partnership
or trust.
This reporting is voluntary for this year, but it is expected to
become mandatory for 2015 returns, says Judy Miller, a retirement
specialist at the American Society of Pension Professionals &
Actuaries.
Legislative changes for retirement plans also could be afoot.
One proposal with bipartisan support curtails the current "stretch"
feature, which allows IRAs to continue for decades after the
original owner's death if the account is left to a much younger
heir.
The proposal would limit the stretch provision to five years
after the owner's death, unless the IRA is inherited by a spouse,
with a few exceptions. Ms. Miller says the provision has narrowly
escaped twice before but may not survive for long.
What about President Barack Obama's proposal, dating from last
year, to prohibit contributions to IRAs and other retirement plans
with more than about $3 million of assets? Because of its extreme
complexity, it is considered a "nonstarter," Ms. Miller says.
Comprehensive tax reform--which House Speaker John Boehner (R.,
Ohio) recently said is a possibility next year--could well bring
changes to retirement plans, which receive tax breaks of about $140
billion a year.
So far, experts say, none of the current proposals would impose
a tax on assets that already are in retirement plans, although
several would curtail contributions from higher-bracket
taxpayers.
The bottom line: if you have an IRA that holds nontraded assets,
make sure to cross every "T" and dot every "I" for the IRS. Don't
count on your IRA surviving you for many decades. And consider
maximizing contributions to tax-sheltered retirement plans now,
while the tax benefits for contributions are intact.
Email: taxreport@wsj.com