It’s no secret that the federal government needs more revenue going forward. Congress could put the Treasury on autopilot to raise billions (and ultimately tens of billions) year after year. Guided by fairness, it could enact spend-down rules for non-retirement accounts that mirror those for retirement accounts: at age 70 ½, require minimum distributions and tax all gains at ordinary income rates.
Let’s look first at the tax policy drawn up by lawmakers to govern the original individual retirement accounts (IRAs) in 1974. Then let’s see how the same policy points to duplicate rules for regular, non-retirement holdings.
Congress gave generous tax breaks to IRAs all through the build-up years. In fact they’re tax-free, starting with contributions and including realized and unrealized capital gains, capital gains distributions, and dividends. If markets rose (a solid long-term bet), compounding would add hugely to the value of the breaks.
On the back end, legislators turned the accounts into a fair and far-sighted bargain. They elected to tax all withdrawals as ordinary income—including the capital gains, normally taxed at much lower rates (currently 15%). Under this mandate, taxes that were forgiven all along are continually recouped at ordinary income rates as retirees cash in.
So it is that IRAs, 401(k)s and the like yield tens of billions in federal income taxes every year—all of which is actually repaying America for those decades of tax breaks. According to the latest estimatefrom the Internal Revenue Service, taxable income from retirement accounts (not including pensions and annuities) totaled over $254 billion in 2016.
For legislative foresight, it’s hard to beat the taxation rules laid down for retirement accounts. More revenue is streaming into the Treasury precisely when an aging America needs every dollar it can get—to shore up Medicare, Medicaid and Social Security, to replace and repair infrastructure, to see that more Americans get a college education, there’s no end to the nation’s pressing (and costly) needs.
Presciently, the annual inflow of new retirees means that revenue from retirement accounts is almost certain to increase. The actual numbers of course depend heavily on the stock market, which in the large has been a major plus. Wall Street’s bull run has surpassed 3,452 days, making it “the longest on record by most definitions.”
In another revenue boost, even the affluent who don’t actually need the money have to begin drawing down and paying back. Minimum distributions begin at age 70 ½ and continue at slowly increasing percentages each year.
On to non-retirement accounts and the case for treating them in like fashion. Holders of such accounts are also indebted to the Treasury for decades of tax breaks; they too should be required to take minimum distributions starting at age 70 ½, with the realized capital gains taxed at ordinary income rates.
Year after year, all their reported investment income gets taxed at a preferential rate. Year after year, they can avoid capital gains taxes by not realizing their gains—by simply buying and holding, while the markets and compounding drive the gains ever higher.
There’s also a final break that costs the Treasury dearly. In an egregious giveaway, unrealized capital gains can be wiped from the books by passing the holdings along to an heir. Through a loophole called the stepped-up basis, the value at the time of the transfer becomes the heir’s basis—erasing, and leaving untaxed, all the accumulated gains in the account. That break would vanish if Congress made minimum distributions a universal rule.
The comedian Rodney Dangerfield rose to fame with a signature line, “I don’t get no respect.” Retirement accounts, the vast majority defined-contribution, get no respect either. They’re regularly attacked for shifting the retirement savings burden to workers; far better and more secure, the critics say, were the defined-benefit pension plans that employers paid.
True enough—but there’s been little recognition of how completely defined contribution plans have outdistanced traditional pensions. Worker participation rates long ago eclipsed the pre-IRA highs. Total retirement savings have soared; likewise for company contributions. Lastly, as a fairness bonus, taxing capital gains the same as wages makes for less income inequality.
Over time though, the most inspired contribution of defined contribution accounts has to be those endless tens of billions in payback headed for the Treasury. Congress could (let’s make that should) raise the revenue numbers another notch by applying the minimum distribution rule to regular accounts.
After all, why should retirement accounts be the only ones repaying the Treasury for tax breaks?