Over the last few weeks, I've had close to 30 consultations with Nestmann Group clients. And one of their top concerns is that Barack Obama or some future US president will find a way to confiscate the money in their IRAs or 401(k) plans.
It's not going to happen. Now, I know that's not what you're reading from some of my colleagues covering the wealth preservation and asset protection beat.
What's more, if I'm wrong and the government does confiscate retirement plans or requires them to make mandatory investments (e.g., in long-term government bonds, etc.), the solution some of my colleagues have suggested won't protect the assets in your plan.
It's All About Politics
More than 11 million Americans have IRAs. The average balance, according to a recent study by Fidelity Investments, is about $89,000. That amounts to about $1 trillion in money parked away for retirement.
Even more popular than IRAs are 401(k) plans. About 52 million Americans have them, with an average balance of around $86,000. That amounts to about $4.4 trillion.
Could President Obama sign an executive order tomorrow demanding that every dollar in these plans be sent to the US Treasury to pay down the US government's $18 trillion debt?
Yes, he could. There are all kinds of laws and precedents he could invoke to justify an outright confiscation.
But it's extremely unlikely that he will. The 63 million Americans with assets in these plans obviously would be outraged by an outright confiscation of their assets. And there's absolutely no doubt they'd make their displeasure known in the streets and the halls of Congress. Simply put, if Obama or any other president tried this gambit, he'd be impeached in a matter of days or weeks.
What Will Happen
That's not to say that Congress and the president wouldn't like to confiscate your retirement funds. They'd do it in a heartbeat if they could find a way to do so without enraging 63 million voters.
What they're doing now, though, is changing the rules for larger retirement plans. Last month, the US Government Accountability Office published a statistical breakdown of IRA balances. More than 99% of Americans have balances of less than $1 million in their IRAs. But about 9,000 Americans have IRAs of $5 million or larger. And 314 Americans have IRAs larger than $25 million. That last number includes the enormous $102 million IRA that presidential candidate Mitt Romney has amassed.
These larger plans are definitely in the government's crosshairs. And since we're now dealing with the "rich," no real political obstacles to changing the rules exist. Or, as Senate Finance Committee Chairman Ron Wyden (D-Oregon) puts it, "The IRA was never intended to be a tax shelter for millionaires."
One idea is to restrict contributions to tax-advantaged retirement accounts. For instance, in 2013, President Obama suggested ending tax-deductible contributions to IRAs and 401(k)-style plans once their combined account balances exceeded $3.2 million.
Other ideas are to restrict using IRAs to buy non-public classes of stock or partnership interests that could balloon in value once inside the account. These are two of the techniques Mitt Romney used to supersize his IRA. There's even some sentiment in Congress to impose a one-time tax on assets already in retirement plans over a certain size.
Why the Confiscation Solution You've Read About Won't Work
To deal with the possibility of confiscation, some advisors promote a concept called a "checkbook IRA." This is an arrangement in which the IRA forms a legal entity (such as an LLC) and then invests through that entity, without having each transaction reviewed by a custodian. That entity owns accounts and other property in its own name, not the IRA's name. You literally have "checkbook control" over your plan.
In the event of nationalization or forced repatriation, your IRA custodian may not be able to comply with the order to turn over assets in your plan if the only asset is the LLC. The government could always try to seize the assets in the LLC itself or foreclose against the IRA's membership interest in it. But if the LLC were formed outside the US, it would be virtually impossible for it to do so.
Is that a great way to checkmate the IRS or what?
Not quite. The problem is that if your IRA failed to comply with the nationalization or repatriation order, it would no longer comply with then-current US law. This would result in a deemed distribution of the entire plan, leading to significant federal and state tax liabilities, possible early distribution penalties if you're under 59 1/2, plus any penalties that might apply for noncompliance with the order. You could wind up owing a tax bill of 50% or more of the assets in the IRA.
Now, I'm not telling you not to have a checkbook IRA. It can be an incredibly flexible instrument for making investments that your IRA custodian simply might not want to deal with – such as offshore investments. Just keep in mind that this won't shield you from the legal consequences of noncompliance with a future confiscation order (which, again, I think is highly unlikely, especially for IRAs or 401(k) plans under $1 million).
One More Thing Not to Forget…
There's also something that the people who push checkbook IRAs almost always forget to mention, except in the fine print: what the IRS calls "prohibited transactions."
A prohibited transaction terminates the IRA and ends all tax deferral and asset protection for the funds inside it. Once again, you have a deemed distribution and a big tax bill. A 401(k) plan – but not an IRA – can often recover from a prohibited transaction by undoing it and paying a small penalty.
Most prohibited transactions boil down to some type of self-dealing with your plan. And the risk of such a mistake skyrockets with checkbook IRAs, since no custodian needs to approve the transaction.
The chances of getting caught in a prohibited transaction are increasing as well. Impending changes to IRS reporting forms for IRAs will require LLCs, such as those used in checkbook IRAs, to be specifically identified. This could lead to increased scrutiny of checkbook IRAs in general.
The bottom line is this:
Don't worry about Congress or Obama confiscating your IRA or 401(k), especially if you have less than $1 million in it
If you have (or are considering) a checkbook IRA, get professional advice from an attorney who specializes in pension and retirement issues before you make anything other than the most "vanilla" investments.
One more point: It's perfectly legal to target offshore investments in your IRA or 401(k). You can purchase real estate, precious metals, securities, and almost anything else in your plan and have the assets held outside the US.
Yes, it's important to follow the rules. But it's definitely possible – we've helped hundreds of clients internationalize their retirement plans over the years.