Senate Finance Committee Chairman Max Baucus is proposing tougher requirements on inherited individual retirement accounts that would require younger beneficiaries to pay taxes over five years instead of spreading them over their lifetime.
The changes, to be considered by his committee today, would raise $4.6 billion for the Treasury over the next decade, according to a statement from the senator's office. Baucus, a Montana Democrat, wants to use the money to help pay for a highway bill the panel is debating in Washington, the statement said.
Baucus's proposal would curtail a tax-planning technique that allows the buildup of tax-free gains inside inherited retirement accounts. Currently, holders of inherited IRAs can take their required taxable distributions over their anticipated lifespan.
“It would really change the whole playing field for retirement planning,” said Ed Slott, an IRA adviser in Rockville Centre, New York. “That would make things simpler, but it would really put a crimp in the whole legacy planning people do for IRAs.”
Baucus hasn't released the full details of the proposal. A one-paragraph summary said it would make exceptions for people who are the same age as the account holder, people older than 70 and children with special needs. Owners of regular IRAs must begin taking taxable distributions at age 70 1/2.
Depending on how the bill is written, beneficiaries in some cases might be able to use rollovers into their own IRAs to avoid the required distributions, said Mary Ann Mancini, who leads the private client group at Bryan Cave LLP in Washington.
Much Older Spouses
Mancini said people who inherit IRAs from much older spouses could be hurt.
She said many of her clients don't use IRAs as an estate- planning tool because beneficiaries often want to spend their inheritances.
“If you can keep it in the IRA with tax-free growth, the longer you can keep it in the IRA, people can come out with millions,” she said. “The problem is people don't keep it in the IRA. Young people want the money.”
Baucus's proposal would return IRAs to their intended purpose as a retirement savings tool and not an estate-planning tool known as a stretch IRA, Slott said. The change, if enacted, would cause people to spend the money in their IRAs rather than leave it as an inheritance for their children, he said.
“It sounds good, but I think it's a nonstarter,” Slott said. “There's too much invested in the whole stretch IRA concept.”
John Olivieri, a partner in the private clients group at White & Case LLP in New York, said the change could increase the taxable income of heirs each year for five years and may push them into a higher income tax bracket, he said.
Another potential benefit to the federal government is that because distributions would be taken out faster, there would be less time for the money to accumulate in the IRA tax-free, Olivieri said.
“Once the money is out of the account it can no longer grow tax-free,” he said. “That's where the government may be planning to get the most benefit from this.”