Stretch IRA May be Disappearing Soon

Short of calling your representatives in Congress and hollering, there’s not much any of us can do about a proposed change to the rules that govern IRAs, reports nj.com in the article “Your kid’s inheritance could take a giant tax hit if these bills become law. Thanks, Congress.”

For years, non-spouse beneficiaries who inherit IRAs have had the ability to stretch out required distributions over their lifetimes. That meant that inherited IRAs could say safe and sound out of the IRS’s reach, except for annual distributions that were quite small. If a grandchild inherited the IRA, the wealth stretched even further.

Depending on the final details of the legislation, the only people who will be able stretch an IRA will be spouses.

Current rules require non-spouse beneficiaries to take required minimum distributions (RMDs) every year over the course of their life expectancy, as per the IRS life expectancy tables. Because they are taken over the lifetime of a younger beneficiary, they can be small. This means the impact of the distribution on the individuals’ income taxes are minimal and the IRA can grow tax deferred over a long period of time.

Congress is looking for revenue, and the wealth of Americans in IRA accounts is in their sight lines.

First, the House passed the SECURE Act, which says that beneficiaries must completely empty their inherited IRAs within 10 years of ownership. The Senate then passed the RESA Act, which is a little different. It would allow a stretch for the first $450,000 of aggregated IRAs, then anything over that would have to be distributed within five years.

Both bills call for changes to apply to inherited IRAs and inherited Roth IRAs for deaths after December 31, 2019. What’s the bottom line? The Joint Committee on Taxation expects that these changes, if they become law, will yield $15.7 billion—with a “B”—in additional tax revenue through 2029.

The government would eventually get this money anyway, but this speeds things up considerably.

Let’s compare and contrast. An 80-year old woman has a traditional IRA worth $1 million. She dies and her 55-year-old daughter is the primary beneficiary. Under the current rules, the daughter’s first RMD is roughly $35,000. If the 25-year-old granddaughter was the beneficiary, the RMD would be roughly $18,000.

If the account earns an average of 5% annually, under the current rule, the granddaughter would have distributions of some $220,000 over ten years. If she had ten years to take the money out, she’d have about $1.3 million in distribution. Under the current rule, the account would have a $1.3 million balance after ten years, since the principal would continue to appreciate. Under the proposed rules, after ten years, it would be zeroed out.

The forced larger distributions will push heirs into higher tax income brackets. That will be followed by increased Medicare premiums, as heirs retire with higher income. Add to that: higher capital gains rate, from as low to zero to as high as 20%. If that’s not bad enough, it could also trigger the 3.8% net Investment Income tax.

One option is to move funds from a regular IRA to a Roth IRA, assuming the investor meets all the requirements to do so. The Roth IRA distributions would not be taxable (unless those laws change) but that also requires the current owner to pay taxes on funds moved to the Roth IRA.

Another option is to consider a Charitable Remainder Trust (CRT) that names a charity as the IRA beneficiary. Upon the death of the owner, the IRA is distributed to the CRT, and the IRA owner’s heir would receive a fixed percentage of the CRT’s value for the remainder of their lives. When the heir dies, the money in the CRT goes to a charity or charities designated by the IRA owner, when the trust was created.

For now, these are proposed pieces of legislation, but chances are good they will be passed soon. Now is a good time to meet with your estate planning attorney to do what you can to protect your IRA and your children’s inheritance.

Reference: nj.com (June 10, 2019) “Your kid’s inheritance could take a giant tax hit if these bills become law. Thanks, Congress”

Suggested Key Terms: Stretch IRA, Retirement Accounts, Required Minimum Distribution, Roth IRA, Charitable Remainder Trust, SECURE Act, RESA Act, Estate Planning Attorney

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Is My Irrevocable Trust Revocable?

Irrevocable trusts aren’t as irrevocable as their name implies, according to Barron’s recent article, “Are Irrevocable Trusts True to Their Name?” The article says that, for both new and existing trusts, there are ways to build in flexibility to make changes to a grantor’s wishes, if terms are no longer appropriate or desirable for beneficiaries.

However, there are strict rules that apply. These rules vary between states. One of the main reasons for an irrevocable trust, is to remove assets from an estate for estate tax purposes. If the rules aren’t followed carefully, a trust can be rendered unlawful. If that happens, the assets may be returned to the grantor’s estate and estate taxes may apply.

If you want to be certain that beneficiaries have some discretion in the future if circumstances change, grantors should build flexibility into the trust when it’s established. This can be accomplished by giving a power of appointment to beneficiaries. However, if the beneficiaries are looking to change the terms or the structure of an existing trust, the trust must be modified, according to state law.

Most states allow trusts to be decanted. When you decant a trust, you pour its terms into a new trust, and leave out the parts that are no longer wanted. Just like decanting a bottle of wine, it’s like the sediment left in the wine bottle.

In a state that doesn’t permit decanting, a trustee can ask a judge to allow it. You should be careful with decanting, because you don’t want to do anything that would adversely affect the original tax attributes of the trust.

The power of appointment in a trust or the ability to decant can’t be given to the person who set up the trust. Thus, grantors can’t have a “re-do” or rescind the terms. It’s only trustees and the beneficiaries that can do that.

If you and your attorney create a trust with a lot of flexibility for the trustee, you may want to appoint an institutional trustee from a bank, trust, or other financial services company.

They can be either the sole trustee or serve as co-trustees with a personal, non-institutional trustee, like a family member. This can help to eliminate future conflicts.

Reference: Barron’s (June 18, 2019) “Are Irrevocable Trusts True to Their Name?”

Suggested Key Terms: Estate Planning Lawyer, Irrevocable Trust, Asset Protection, Probate Court, Inheritance, Power of Appointment, Decanting

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How Will the Secure Act Changes IRAs and RMDs?

The House has passed what could be a landmark retirement law that will impact workers, retirees and heirs. Some of the most important provisions will modify existing retirement plans.

Kiplinger’s recent article, “Secure Act Calls for Changes to IRAs, RMDs,” reports that IRA owners should understand some of the key provisions of the bipartisan Setting Every Community Up for Retirement Enhancement Act of 2019. This bill passed the House in a 417-3 vote and is now in the Senate’s hands.

The three changes that are discussed below will go into effect after December 31, 2019, provided the House bill is enacted as written.

The Age Cap Repeal. The Secure Act gets rid of the age cap for traditional IRA contributions, which is now at 70½. This would let older workers save some of their earned income in a traditional IRA, just as they can now in a Roth IRA. For those 50 and older in 2019, the maximum contribution is $7,000. An older worker who has enough income to cover the total IRA contributions, could also contribute to a spousal IRA for a retired spouse.

An Increase in the RMD Age. The House bill increases the starting age for required minimum distributions (RMDs) from retirement accounts to 72, from 70½. That’s a win for older workers and retirees, who don’t need to tap their retirement accounts to cover expenses. Because the change would be effective after December 31, 2019, people who turn 70½ in 2020 would be the first to benefit. IRA owners currently taking RMDs wouldn’t be impacted.

The Loss of the “Stretch IRA.” Although the Act may benefit some retirement account owners, it’s not so nice to non-spouse heirs. The bill would get rid of heirs’ ability to stretch out RMDs from inherited retirement accounts over the non-spouse heirs’ own life expectancies. This currently allows more of the money to grow tax-deferred and lessens the heirs’ income tax bill. However, the Act would require inherited assets to be withdrawn within 10 years. Beneficiaries of larger accounts could have much bigger IRA withdrawals, as well as larger tax liabilities, than they’d anticipated.

This change will require some additional estate planning for many IRA owners. Heirs will need to review their tax-planning strategies, if they receive a windfall. Repealing the age cap on contributions and raising the age for RMDs could be beneficial to some, but retirees would have to weigh that with accumulating too much in an IRA. The loss of the stretch could make Roth accounts more attractive, because heirs can withdraw Roth money tax free.

Reference: Kiplinger (June 14, 2019) “Secure Act Calls for Changes to IRAs, RMDs”

Suggested Key Terms: Estate Planning, Legislation, IRA, Roth IRA, Required Minimum Distribution, RMD, Asset Protection, SECURE Act

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