New report addresses concerns about large retirement accounts
Recent stock market gains have improved the status of our retirement account balances, and more than the account owners have taken notice of the asset value increases. The federal government apparently has shown recent interest in the size of retirement account balances.
Approximately two months ago, we commented on a General Accountability Office report on Individual Retirement Account asset balances. The 11-page GAO report indicated future reports would address specific issuses or concerns with respect to IRA accounts.
The GAO kept its promise and, during the week of Thanksgiving, issued a 90-plus page report entitled “IRS Could Bolster Enforcement on Multimillion Dollar Accounts, But More Direction from Congress is Needed” (gao.gov/assets/670/666595.pdf).
The report takes the IRA balance data in the September report and provides observations and recommendations as to how taxpayers were able to accumulate large IRA balances and what Congress and the Internal Revenue Service should consider going forward.
In the September report, the GAO indicated 99 percent of all IRAs (based on 2011 data) have balances of less than $1 million. The report also indicated approximately 45,000 taxpayers own IRAs with asset balances of more than $3 million, and nearly 600,000 have balances between $1 million and $3 million. As mentioned in the earlier column, values of IRAs as well as the number of million-dollar accounts have likely increased given the stock market gains in the past three years.
The GAO report is written in a tone of concern regarding whether such wealth accumulation by certain U.S. individuals is consistent with the intent of allowing IRA accounts for taxpayers. The history of IRAs indicates Congress enacted the IRA provisions (including the Roth IRA) to provide individuals with retirement plan options that provide income tax deferral (income tax exemption in the case of a Roth IRA) to enable individuals to maintain their standard of living during retirement. Congress also placed annual contribution limits on the amount an individual is permitted to contribute.
It is likely many of the large account balances cited in the report are, in part, the result of rollovers from employer qualified retirmenet plans such as 401(k) plans. The account balances in the employer plans were rolled over when the employee terminated employment or retired from the employer.
The IRS receives annual information from IRA custodians with respect to the amount of the fair market value of assets in an IRA This information is reported on Form 5498 and a copy is provided to the IRA owner. The 2014 form has been revised to allow more detailed information to be provided to the IRS on the type and value of IRA investments. It is the data on 2011 Forms 5498 that the GAO is using in its recent reports. The IRS has also issued guidance regarding permitted and not permitted transactions and investments within an IRA account.
The report focuses on two types of asset groups it has identified as allowing for large account balances: non-publicly traded shares of companies and partnership interests in such investments as hedge funds, venture capital funds and private equity funds. Most IRA investments are in public securities and not in non-public shares or partnerships.
The concerns expressed deal with how these private investments are valued when the IRA acquires the investment in private company shares or an equity interest in partnerships. Investment in the asset classes isn’t uncommon for some retirement plans. These types of investments are often made by employer pension plans, and government and tax exempt pension plans. Many pension plans have specific allocations for their portfolios in such alternative investments. So, the use of these types of investment options by IRA owners is not that different from what is done in many employer and government pension plans.
The impact of private investment in some situations is quite compelling. The GAO report cites a Wall Street Journalreport on the investment returns realized by employees of a private equity fund when the employees’ IRA accounts invested $25,000 in a fund portfolio company that turned into $14 million two years later when the portfolio company went public. The WSJ report indicated the employees ultimately sold the investment for $23 million representing a return of nearly 1,000 times the original investment.
The GAO report encourages the IRS to focus on areas where noncompliance may exist with the large IRA accounts. This includes the valuation of alternative assets when an investment is made. The report makes several recommendations to the IRS and Congress regarding IRAs including the build-up of large IRA asset balances by limiting the types of investments an IRA may hold, applying valuation standards, and placing a ceiling on IRA balances and requiring distributions on any IRA plan accumulations above that ceiling.
The limitation on the size of asset balances in retirement accounts is something we have heard before. As discussed in September, there are Obama Administration and Congressional proposals to limit the value of retirement account balances. Prudent savers and investors may see limits on how much can be accumulated for retirement purposes.
While many of us may not own one of the $5 million retirement accounts mentioned in the GAO report, proper planning and investment returns can provide significant opportunities for accumulating significant retirement assets. With a new year approaching, consideration for adjusting 401(k) deferral percentages, adding to an existing IRA, or opening a new IRA account should be on all of our “to do” lists. This may allow our accounts to grow large and, perhaps, to one day make the list in a GAO report.
Bill Roth is a tax partner with the local office of accounting firm BDO USA LLP. The views expressed are those of the author and not necessarily of BDO. The comments are general and not to be considered specific tax or accounting advice and cannot be relied upon for the purposes of avoiding penalties. Readers are advised to consult with their professional advisers before acting on any items discussed herein.