The administration’s fiscal 2016 budget addresses employer-sponsored health, retirement and compensation programs with a focus on improving the finances of the middle class. Earlier budget submissions included many of the same proposals, such as capping contributions and accruals in tax-preferred retirement accounts as well as the tax preferences for employer-provided health care and retirement benefits. Other items, such as supporting state retirement initiatives and eliminating dependent care reimbursement accounts, are new this year.

Retirement proposals

The budget would cap total retirement accumulations, increase premiums charged to sponsors of defined benefit (DB) plans by the Pension Benefit Guaranty Corporation (PBGC), establish automatic individual retirement accounts (IRAs) and limit the value of tax exclusions for retirement savings. To encourage retirement saving and retirement plan sponsorship, a new proposal would expand retirement coverage for part-time workers. Other budget proposals would eliminate minimum required distributions for certain individuals and impose a timeline on distributions from inherited IRAs.

Establish cumulative cap on retirement account balances

The proposal would limit total tax-favored retirement accumulations to an amount that would provide the maximum annuity permitted under a DB plan, currently $210,000. Rather than a dollar cap that applies equally to all plan participants and account holders, this retirement cap would vary by the participant’s age as well as by underlying assumptions, including interest rates. While discussions of the retirement cap often cite the $3.4 million that would apply to a 62-year-old in 2015, the limit would be lower for younger participants and would drop for all participants if interest rates increased.1

The retirement cap would apply to all amounts accrued or accumulated in tax-favored retirement arrangements, including DB plan accruals, and savings in defined contribution (DC) plans and IRAs.

Implementation would be complicated. For DC and IRA balances, trustees would report year-end account balances and contribution amounts for the year, and the amount would be converted to a 100% joint and survivor annuity payable at age 62. DB plan sponsors would report the individual’s accrued benefit and accruals for the year, payable in the same form. The limitation would then apply to contributions and accruals for the following year. Taxpayers who exceeded the limits could not contribute further and accruals would be prohibited, but investment gains and earnings would be allowed.

Raise PBGC premiums

The proposed budget authorizes the PBGC board to set premiums for single- and multiemployer plans and directs the agency to consider risk when setting premiums. The proposal is estimated to provide $19 billion over the next 10 years. 

Establish automatic IRAs

The budget would require employers that don’t already sponsor a retirement plan to enroll their employees in automatic direct-deposit IRAs. Retirement plan sponsors that exclude certain populations (such as all employees of a division or subsidiary) would have to facilitate automatic IRAs for the excluded employees. Default contributions of 3% of compensation would be deposited in a Roth IRA, but employees could choose traditional IRAs, contribute more or less than 3%, or opt out of the IRA altogether. 

Cap the tax exclusion for retirement benefits

The proposal would cap the value of itemized tax deductions and certain tax preferences at 28% for taxpayers in higher tax brackets. Specified exclusions would include employee contributions to DC plans and IRAs. 

Expand coverage for part-time workers

The proposed budget would allow employees who worked 500 or more hours for at least three consecutive years to contribute to an employer-sponsored 401(k) plan. Employers would not be required to contribute, but employees would receive a year of vesting credit for each 500-hour working year.

Encourage state retirement initiatives

The proposal would set aside $6.5 million for state initiatives mandating automatic IRAs for employees who lack access to a workplace retirement plan and allow a limited number of states to implement such programs.

Repeal 404(k) ESOP dividend deduction

The budget would repeal the 404(k) employee stock ownership plan dividend deduction for publicly traded corporations. 

Address minimum required distributions

Retirees with aggregate balances of $100,000 or less in their retirement plans would not have to take minimum required distributions (up from $75,000 proposed in the fiscal 2014 budget). In addition, Roth accounts would be subject to the same minimum distribution rules as traditional retirement arrangements.

Make some distributions from inherited IRAs mandatory

Non-spouse beneficiaries would have to take distributions from inherited IRAs within five years, unless the beneficiary was disabled, chronically ill or less than 10 years younger than the deceased. Minor beneficiaries would have to take distributions within five years of reaching the age of majority. The provision has been discussed repeatedly as a potential revenue raiser and is likely to receive more attention this year. The budget also addresses rollover options for inherited IRAs and DC accounts.

Require employers to submit more information with electronically filed Forms 5500

The proposal would allow the IRS to require plan sponsors to file information on employee benefit plan tax requirements with their Forms 5500 (annual reports) electronically.

Report employer contributions to DC plans on W-2s

Employers would have to report their contributions to employees’ DC plans on Form W-2. According to the Green Book, this would give workers a better understanding of their overall retirement savings and facilitate compliance with the annual limits on contributions to DC plans.

Allow for portability of annuities

If a retirement plan ceases to offer an annuity investment option, plan participants could take a distribution of a lifetime income investment through a direct rollover to an IRA or other retirement plan. The rollover would be permitted regardless of whether another distributable event had occurred and would not be subject to an early withdrawal penalty.

Allow unemployed workers to make penalty-free withdrawals from retirement accounts

The budget would allow unemployed workers who have received unemployment compensation for at least 26 weeks (or, if less, the maximum period available under state law) to take penalty-free withdrawals from their retirement accounts. Withdrawals would have to be taken during the taxable year in which unemployment compensation was first paid or the next year and would be subject to certain limits.

Repeal exclusion for net unrealized appreciation in employer stock

The proposal would repeal the exclusion for net unrealized appreciation of employer stock in the year of distribution for participants in tax-qualified retirement plans who are younger than 50 on December 31, 2015.

Limit Roth conversions to pretax amounts

Conversions of aftertax amounts in IRAs or employer-sponsored plans to Roth amounts would be limited.

Health care proposals

The budget proposes to fully fund continued implementation of the Patient Protection and Affordable Care Act (PPACA). Like earlier budget submissions, it would limit the tax exclusion for employer-provided health care for higher-income taxpayers. The budget would also make targeted changes to Medicare — most of which also appeared in earlier budget proposals.

Cap tax exclusions for employer-provided health coverage

The proposal would cap itemized tax deductions and specified tax exclusions at 28% for taxpayers in higher tax brackets. The specified tax exclusions include employer-sponsored health insurance paid for by employers or with pretax employee dollars, contributions to health savings accounts (HSAs) and Archer medical savings accounts (MSAs), and health insurance costs of the self-employed.

Make changes to Medicare

Among other proposals, the budget would:

  • Increase means-tested Part B and Part D premiums
  • Increase the Part B deductible for new beneficiaries starting in 2019
  • Impose a Part B premium surcharge on new Medicare beneficiaries who purchase first-dollar supplemental coverage
  • Authorize the Department of Health and Human Services to negotiate the price of biologics and high-cost drugs under Part D
  • Close the coverage gap for brand-name drugs in Part D by 2017 instead of 2020
  • Improve “payment accuracy” for Medicare Advantage plans
  • Align employer group waiver plan payments with average Medicare Advantage bids

Compensation and governance

The budget would fund the continued implementation and enforcement of the Dodd-Frank Wall Street Reform and Consumer Protection Act and increase funding for the Securities and Exchange Commission and the Commodities Future Trading Commission. Most of the compensation proposals also appeared in earlier budget submissions, and their goal is to eliminate or at least weaken some tax shelters used by the wealthy.

The administration proposes to expand the pro rata interest expense disallowance for corporate-owned life insurance (COLI) to cover employees, officers and directors (other than 20% owners) of the business that owns or is the beneficiary of the life insurance contract. 

The proposal would tax carried interest at ordinary income tax rates and require partners in investment firms to pay self-employment taxes on the income. Taxpayers would have to use average cost basis rather than “specified identification” for all identical securities with a long-term holding period. Gifts and bequests would trigger a tax liability for capital gains.

Other provisions

The theme of this budget is improving the finances of middle class and working families. President Obama calls on Congress to raise the minimum wage and address pay equity. The budget also supports state initiatives to expand paid family and medical leave. Other proposals would:

  • Eliminate dependent care reimbursement accounts (DCRAs), which the budget claims are complex and poorly targeted
  • Make the maximum Child and Dependent Care Tax Credit available to families with incomes up to $120,000; the credit now starts to decline at more than $15,000 (the budget also proposes to triple the maximum Child and Dependent Care Tax Credit for families with children under age five)
  • Index all penalties in the Internal Revenue Code to inflation
  • Impose a fee on the liabilities of financial firms
  • Clarify worker classification

Budget documents are available from the Office of Management and Budget (OMB) and the Treasury Department at the following links:

Outlook

The budget sets out the administration’s priorities for fiscal 2016. While budget proposals become the subject of both congressional hearings and media attention, they are not expected to move through Congress in their entirety. But House and Senate committees are already conducting hearings on the proposal, and some items — especially those that raise significant revenue — could be reintroduced by lawmakers working on the budget, deficit reduction and tax reform.


Endnote

1. For a discussion of these caps and their effects on workers, see Brendan McFarland and Sylvester Schieber, “Proposed Lifetime Pension Limits: Less Than Meets the Eye,” Towers Watson Insider, March 2014.