ó Retirement accounts and estate plans may soon be
taking a major hit from the IRS, if Congress decides
early next year to change the rules on a tax strategy
involving inherited IRAs that many affluent families
have used to their advantage for years.
current rules, people who contribute to an individual
retirement account and donít need the money to meet
retirement living expenses are able to pass the account
along to their heirs. That money is then allowed to keep
growing tax-deferred throughout the heirsí lifetime,
with minimal taxes due on the withdrawals.
the ability to stretch an IRA across generations could
be coming to an end.
Senate Committee on Finance voted 26-0 in September to
kill the "Stretch IRA" for non-spousal
beneficiaries ó putting trillions of dollars of legacy
wealth in danger of being collected by the tax man.
is going to be big," said James Lange, a
Pittsburgh-based tax accountant, attorney and author.
"Itís not a done deal. Itís not immediately
effective. But in the past when you had a 26-0 Senate
vote, the legislation always became law the next
Senate proposal will be included in a bill called the
Retirement Enhancement and Savings Act, and would
require beneficiaries of an inherited IRA or other
qualified retirement account to pay all taxes due on the
account within five years of the ownerís death.
proposed law does not apply to surviving spouses.
Surviving spouses may still spread the taxes due on the
account across their life span or roll the money into
another retirement account.
it stands, the proposal includes a $450,000 exclusion,
which applies to non-spouse beneficiaries. A $1 million
inherited IRA would only be subject to taxes on
proposed rule would not affect Roth IRAs because taxes
on those accounts have already been paid with after-tax
income by the account owner.
on traditional IRAs are deferred until the account owner
begins making withdrawals to cover living expenses
during retirement. Heirs are required to continue making
annual withdrawals from the inherited account and pay
taxes on those withdrawals. The new rule would
dramatically speed up the pace of those withdrawals.
five-year limit isnít so bad if you are paying taxes
on $100,000, but if you have $500,000 to pay taxes on,
it could be a challenge," said Howard Davis,
president of the Davis, Davis & Associates
accounting firm in Pittsburgh.
has several clients with IRA balances of $1 million or
more. "You could wait until year five to pay the
entire tax bill, but it could also push you into a
higher tax bracket." He said it probably makes more
sense to take out a portion each year to lower the tax
total amount of money at stake is substantial.
U.S. retirement assets were $24.5 trillion as of June
2016, up 1.3 percent from the end of March, according to
the Washington, D.C.-based Investment Company Institute.
Retirement assets accounted for 34 percent of all
household financial assets in the U.S. at the end of
Congress has to wait about 40 years to get the assets in
retirement accounts converted into income tax
payments," said Jim Meredith, executive vice
president of the Hefren-Tillotson financial advisory
firm in Pittsburgh. "If non-spousal beneficiaries
must pay the tax bill off in five years instead of over
their actuarial life span, there will be a huge windfall
for the government.
the average American household, second to the home, the
retirement account is the householdís largest source
of wealth," Meredith said. "The ability to
transfer that wealth to the second or third generation
will fall away with this legislation."
who inherited traditional IRAs have been able to profit
from one of the biggest benefits of the tax code ó
allowing the tax-deferred balance to continue
compounding all those years.
example, assume a son inherits an IRA upon the death of
his father in 2016. The son will turn 53 in 2017, when
required distributions based on his life expectancy
commence. The IRA Single Life Expectancy Table indicates
that at age 53, the son has a 31.4-year life expectancy.
2017, the sonís required minimum distribution amount,
which he would be required to pay taxes on, would be
computed as follows:
balance of his inherited account on Jan. 1, 2017, times
the fraction 1/31.4. For the years after 2017, the son
reduces his life expectancy by one year from what it was
in 2017. So in 2018, his required minimum distribution
fraction is 1/30.4.
minimum required distribution fraction applies to the
sonís inherited IRA even if the son dies. The Internal
Revenue Service really doesnít care who the account
passes to at that point, since it has no affect on the
required minimum distribution rate from the inherited
IRA, which was set in 2017.
trigger for the changing status of inherited IRAs may
stem from a 2014 U.S. Supreme Court decision on a
traditional IRA lawsuit involving Heidi Heffron-Clark,
of Madison, Wis., who became the sole beneficiary of an
inherited IRA when her mother died in 2001.
2010, Heffron-Clark and her husband filed a Chapter 7
bankruptcy petition. They identified the inherited IRA
ó which by then was worth about $300,000 ó as exempt
from creditors on the basis that the money came from a
courts had until then typically held that inherited
retirement accounts may be excluded from a beneficiaryís
bankruptcy estate. However, the Supreme Court ruled
unanimously that inherited IRAs are not "retirement
funds" under the bankruptcy code and are not
entitled to exemption from a debtorís bankruptcy
Supreme Court concluded that inherited IRAs are not
funds set aside for the day when an individual stops
working. The fact that a beneficiary can never
contribute additional funds to the account doesnít
square with the notion that the fund is money the
beneficiary is putting aside for retirement.
Supreme Court said that non-spouses are not
exempt," Meredith said, adding that Sen. Harry
Reid, D-Nev., later proposed that as inherited IRAs are
not retirement accounts, they should receive the same
tax treatment as a non-IRA annuity. That meant the
inherited IRA account would need to be redeemed within
five years of inheritance.
said in a city like Pittsburgh, where a lot of people
never earned a ton of money but were prudent about
setting aside funds into retirement plans, many retired
workers will die with lots of money in those plans.
a lot of Pittsburghers, the IRA is the main source of
wealth in their 60s. What will happen under the proposed
law is IRAs will be taxed more heavily and it will make
a big difference for heirs."