A recent report from the Government Accountability Office finds an estimated 43 million taxpayers had individual retirement accounts as of tax year 2011—the most recent year with full data available—with a total reported fair market value of $5.2 trillion. The report shows few taxpayers had aggregated balances exceeding $5 million as of 2011. Generally, taxpayers with IRA balances greater than $5 million were joint filers who are 65 or older with adjusted gross incomes greater than $200,000.
As the GAO observes, there is no total statutory limit on IRA accumulations or rollovers from workplace defined contribution (DC) plans, which has allowed a small number of taxpayers to accumulate very large IRA balances. For example, while some 42.4 million people have IRAs with a balance below $1 million, only about 600,000 people have passed the $1 million mark—the vast majority of which are sitting somewhere between $1 million and $2 million.
Strikingly, GAO researchers suggest there are about 300 taxpayers with $25 million or more in their IRAs. These individuals likely reached the pinnacle of IRA success “by investing in assets unavailable to most investors—initially valued very low and offering disproportionately high potential investment returns if successful,” the report says.
According to the GAO, individuals who invest in these assets using certain types of IRAs “can escape taxation on investment gains.” For example, founders of companies who use IRAs to invest in non-publicly traded shares of their newly formed companies can realize many millions of dollars in tax-favored gains on their investment if the company is successful.
“With no total limit on IRA accumulations, the government forgoes millions in tax revenue,” the report explains. “The accumulation of these large IRA balances by a small number of investors stands in contrast to Congress’s aim to prevent the tax-favored accumulation of balances exceeding what is needed for retirement.”
The GAO goes on to explain that the federal government will forgo an estimated $17.45 billion in potentially collectable tax revenue from IRAs in 2014 alone. Much of the tax benefit goes to those with outsized IRA balances, researchers explain.
“To promote retirement savings without creating permanent tax-favored accounts for a small segment of the population, Congress should consider revisiting the use of IRAs to accumulate large balances and consider ways to improve the equity of the existing tax expenditure on IRAs,” GAO researchers suggest.
Options discussed in the report include placing limits on the types of assets permitted in IRAs; the minimum valuation for an asset purchased by an IRA; or the amount of assets that can be accumulated in IRAs and employer-sponsored plans that get preferential tax treatment.
Other suggestions raised by the GAO include improving the Internal Revenue Service’s (IRS) ability to detect and pursue compliance problems and prohibited transactions associated with undervalued assets sheltered in IRAs. To this end, the GAO recommends the commissioner of internal revenue should approve plans to fully compile and digitize new data from electronic and paper-filed Form 5498s to ensure the efficient use of the information on non-publicly traded IRA assets.
The report also urges the IRS and the wider Department of the Treasury to work with Congress on a legislative proposal to expand the statute of limitations on IRA compliance issues to help IRS pursue valuation-related misreporting and prohibited transactions that may have originated outside the current statute's three-year limitations window.
The GAO also makes suggestions for better educating taxpayers about taxation and investing rules for IRAs.
“To help taxpayers better understand compliance risks associated with certain IRA choices and improve compliance, the Commissioner of Revenue should, building on research data on IRAs holding non-public assets, identify options to provide outreach targeting taxpayers with non-public IRA assets and their custodians, such as reminder notices that engaging in prohibited transactions can result in loss of the IRA's tax-favored status,” the report continues.
The GAO also recommends the addition of an “explicit caution” in Publication 590 Individual Retirement Arrangements for taxpayers about the potential risk of committing a prohibited transaction when investing in non-publicly traded assets or directly controlling IRA assets.
The full 99-page report is available for download here, along with highlights and recommendations selected by the GAO.