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Will Congress Take Away Your IRA?

Dan Caplinger
February 15, 2012

For decades, tax-favored retirement accounts have given savers their best chance to gather up a big enough nest egg to have a prosperous, financially secure retirement. But as the federal government looks for ways to increase tax revenue, some have feared that the tax breaks that IRAs and 401(k) plans enjoy might be on the endangered list -- and a recent move in Congress brought those fears to the forefront.

On the chopping block?
A recent amendment to a minor piece of legislation set off alarm bells within the retirement savings community. The proposed amendment would have changed the rules governing IRAs to force those who inherit them to cash them out more quickly than current law requires. In the end, the proposal never became part of the final law.

But as the recently proposed federal budget shows, the government is hungry for tax revenue, and one potential source comes from retirement accounts. Although some fears are overblown, others are much more likely to become reality -- and you may want to start planning for them sooner rather than later.

The deal of the century
Perhaps the biggest criticism of retirement accounts from an income-tax standpoint is that under current law, there's a huge incentive for people not to use them for retirement. Consider the following:

  • With traditional IRAs and 401(k)s, you're not required to start taking withdrawals until you turn 70 1/2. Even then, you only have to withdraw about 6% of your retirement nest egg.
  • For Roth IRAs, there's no requirement to make withdrawals at all.

When you combine this with extremely generous laws that allow people inheriting IRAs to stretch out withdrawals over their entire lifetimes, you have the potential for a multigenerational tax windfall that arguably goes well beyond what anyone would have intended for a retirement account.

It's entirely possible that these inheritance laws could be changed to reflect the primary purpose of IRAs and 401(k)s as covering retirement expenses. Forcing accelerated withdrawals would pump more tax revenue into the federal system more quickly, producing the budget savings that Congress is searching for.

That would be good for Uncle Sam but bad for a range of businesses. Some of them would include:

  • Financial companies Bank of America (NYSE: BAC  ) and Wells Fargo (NYSE: WFC  ) have identified retirement plans as an area with huge growth potential, as they beefed up their retirement-plan staffing to try to compete. Similarly, discount brokers E*TRADE Financial (Nasdaq: ETFC  ) and TD AMERITRADE