GAO Says There is Too Much Money in your TSP/401k/IRA

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Recently the non-partisan (cough, cough) GAO conducted a study investigating large (> $5 Million) IRA balances.

According to WSJ, this study was prompted by the disclosures of Mitt Romney and Silicon Valley entrepreneur Max Levchin that they each have IRA balances worth tens on millions.

The GAO concluded in its preliminary study (GAO-14-878T):

In 2014, the federal government will forgo (emphasis mine) an estimated $17.5 billion in tax revenue from IRAs.

GAO will release a separate report with its final results on individual retirement accounts later this fall.

What prompted this study? Congress is reportedly upset about the super-sized IRA balances because (according to GAO) :

Congress limited annual contributions to IRAs to prevent the tax-favored accumulation of unduly large balances, but concerns have been raised that tax benefits accrue primarily for higher -income individuals.

Back to the cases of Mitt and Max…

Super-size IRA balances (Tens of Millions) are easily possible in a few individual instances that are statistically ‘off the charts’- In both cases, employee 401k contributions are matched in company stock, before the company has a liquidity event (such as an IPO). Then the stock value goes from pennies to tens of dollars per share.  At some point the employee rolls the employer plan (401k) balance in to an IRA.

Specific findings of the GAO study:

Even assuming maximum contributions sustained over decades and rolled over from an employer plan, it would take an aggressive stock market investment strategy to accumulate an IRA balance over $5 million.

An individual who made the maximum contributions every year since 1975 to a traditional IRA could have accumulated about $303,420 achieving investment returns equal to the average annual Social Security interest rates. 

Here’s the fallacy of the GAO findings. I recommend they address these gross errors in their study in their ‘final’ report:

1) The IRA tax revenue is not ‘gone’- Uncle Sugar will eventually get his payday from RMD’s (Required Minimum Distributions)

First, the GAO acknowledges:

Generally, taxpayers with IRA balances of $5 million or more tend to have higher adjusted gross incomes, be joint filers, and 65 or more years old.

So what’s the problem here? When an IRA account holder turns 70 1/2, they take ‘Required Minimum Distributions’ (RMD’s) based on their life expectancy. Every penny of these RMD withdrawals from the IRA are 100% taxable as income.
2) Uncle Sugar complains about Inherited IRAs.

…we aggregated IRA data (including inherited IRAs as IRS data do not readily identify inherited IRAs) by tax return.

You mean you’re counting Inherited IRA’s as a problem?

GAO admitted in #1 that persons mostly older than 65 years had the largest IRA balances. And once again, you’re not ‘forgoing’ any revenue on Inherited IRA’s, you’re just stretching out the tax revenue on Inherited IRA withdrawals- Which are calculated based on the same ‘Required Minimum Distribution’ method in #1 above, only stretched out over the lifetime of the inheriting IRA recipient.
3) GAO can’t tell the difference between Roth and Traditional contributions.

The (GAO) study Aggregates Roth and Traditional IRA balances.

What? You’re complaining that the government is about to ‘forgo’ $17.5 billion in revenue, even while admitting that some of the taxes (on Roth IRA and Roth 401k/TSP contributions) have already been paid?  You don’t know what the ratio is between Roth and Traditional IRA contributions? You’ve got to be kidding me.

4) The GAO study does not account for Employer Matching Contributions.

This is the biggest whopper of them all.

Nobody gets filthy rich contributing $5,500 per year to an index fund IRA.

In most cases, the real ‘boost’ in returns in Qualified Plans (In case anyone from GAO is reading, that’s defined by the IRS as 401k’s, Solo 401k’s, TSP’s, 403b’s, and 457b’s) comes from the employer match. Then, at some point in the future, the employee leaves his/her employer and rolls the Qualified Plan balance in to an IRA.

This is how IRA’s get big – from Rollovers.

It’s entirely feasible that a ‘Wage Slave’ defers the maximum $17,500 per year in a Qualified Plan and receives an employer match of $7500 per year- for an aggregate annual 401k contribution of $25,000.

This adds up to $5 million at 7% returns over a 40-year career.

Since GAO is bad at math, I’ll do it for you using my 12C app on my smartphone:

40 [n] ; 7 [i] ; 0 [PV] ; 25,000 [PMT] ; [FV] = $4,990877.80 (or REALLY close to $5 million).

Note that in the case of Solo 401k’s the aggregate contribution can be much HIGHER (up to $52,000 per year in 2014, per the IRS webpage).

5) We’ve never heard of TSP millionaires.

Even assuming maximum contributions sustained over decades and rolled over from an employer plan, it would take an aggressive stock market investment strategy to accumulate an IRA balance over $5 million.

Did the GAO forget about this study done by another Federal Agency (The TSP’s FRTIB)?

There are plenty of TSP millionaires- Hard working Feds who accumulated large retirement balances the old fashioned way – Steady 401k (TSP) contributions combined with employer matching contributions.

In summary, when GAO does its ‘Final’ study of how to ‘avoid’ uber-IRA balances, it needs to address these issues:

1) IRS will eventually get its IRA revenue through RMD’s.
2) IRS will eventually get its inherited IRA revenue, also through RMD’s.
3) IRS (and GAO) need to figure out what IRA contributions have already been taxed (Roth Contributions).
4) IRS needs to account for the employer match in Qualified Plans.
5) IRS needs to acknowledge other Federal Government Studies – And that there are Qualified Plan (TSP) Millionaires, who got there the old fashioned way (savings and compounded returns over time).

 

 

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