# The math of President Obama’s budget proposal to limit IRAs

President Obama’s 2014 proposed budget

Today we started our discussion of finance in my Analytic Methods for Lawyers class. I decided to be very ambitious. I took an item out of the week’s news and tried to show what light could be shed on it using analytic tools.  In particular, I took President Obama’s proposal to limit IRAs. Here’s what he wrote:

“The Budget would limit an individual’ s total  balance across tax – preferred accounts to an amount sufficient to finance an annuity of not more than \$205, 000 per year in retirement, or about \$3 million for someone retiring in 2013. This proposal would raise \$9 billion over 10 years.”

Here’s an interactive exploration of this proposal about individual retirement accounts. Notice, by the way, how this analysis of the IRA relies on a few Mathematica tools. It relies on the TimeValue function along with Annuity and Annuity Due. It also makes heavy use of statistical distributions and transformed statistical distributions.  I’m rather proud that after just a semester, my students were able to follow the discussion. (Or at least said they were too polite to say they didn’t).

And, if you are too intimidated to read on, but just want to get to the bottom line, here’s what I would say. First, you shouldn’t be intimidated. If you can’t follow the code, just look at the text and play with the interactive tools. You’ll still get a lot out of it. Second, here’s what I conclude in the end.

• Saying one will not butt up against the President’ s limit until one has \$3 million seems a bit unrealistic. Figures of \$2 to \$2 .5 million are likely more realistic (assuming the IRS mortality tables are valid).
• Even at \$2 million, it’ s not so easy for the average person to get \$2 million in a conventional IRA given current limits on contributions.

## 2 thoughts on “The math of President Obama’s budget proposal to limit IRAs”

1. Jeremy says:

Your models are interesting, but I think it may be based on flawed assumptions. I am not a math guy, but let me point out areas where I think it may have challenges.

(1) This tax effects all deferred contribution (401k, IRA, etc.), the limit of which in 2013 is \$51k per year, indexed to inflation. Maxing the contribution per year and earning a 7% interest rate, one can hit \$3m in ~24 years. Factoring in 2% inflation, this jumps to 28 years.

(2) Your mortality rate model seems to assume that you are buying an insurance product that would cease paying when you die. As an individual, good luck finding such a product which uses a discount rate of over 2% from a reputable company. Annuities are not FDIC insured, so you are betting the insurance company will be around longer than you. Top companies seem to be using a discount rate of around 1% in my quick google search.

(3) If you are not using an insurance based product, you should use the mortality tables to calculate payments so that there is a 99% chance that you do not run out of money before both you and your spouse die.

(4) You should subtract the expected inflation rate from the rate of return during retirement years to handle an ever increasing annuity payment required to keep up with inflation. With this a life annuity from New York life based on a 1% discount rate, will effectively return -1% after a 2% inflation adjustment.

(5) Even assuming you are investing directly in stocks and bonds, no one earns 7% in retirement. The stock market may on average return more than 7%, but a portfolio of 100% stock is not appropriate for those nearing retirement or in retirement. A more appropriate range is 1% to 3%. A 30 year retirement income of \$205k which has a payment which increases with inflation at 2% per year, would require a \$5.3m to \$7.2m in present value at the point of retirement. To save \$5.3 to \$7.2m at 7% ROI with 2% annual inflation, contributing \$51k per year, and increasing contributions at a rate of 2% per year, would require 33 to 38 years of maximum contributions before retiring.

2. Regarding the statements:
the most one can contribute to a conventional IRA in a year is \$5,000 per year though the amount is increased to \$6,000 per year at age 50 and above. The code below shows that if one worked for 50 years starting at age 20 and put the maximum amount in each year, it would still take an average return of over 7.8% to have \$3 million

First, Obama is referring to the sum of 401K + IRA money. If your employer has a 401K program, you can contribute substantially more than \$5,000 per year. Additionally, many employers match employee’s 401K contributions which further increases the amount invested. Second, some employers pay their employees the cash equivalent of an annuity upon retirement. This would add yet more to the amount invested. News reports indicate that Mitt Romney has managed to stash \$100 million in his IRA because he’s made a lot of money and must have a clever accountant.