Sunday, January 19, 2020

Did Stretch IRAs Deserve to Die?

Individual Retirement Accounts began as simple way to put aside a few bucks. With the passing years, limits on annual IRA contributions increased and top income earners started moving megabucks into rollover IRAs.  Estate planners took notice.

Assets remaining in IRAs and 401(k)s at the owner’s death could be passed to a named beneficiary, and not necessarily in a lump sum. Distributions could be stretched over the beneficiary’s lifetime. Planners saw the potential for “inheritances" that offered many years of tax-deferred investment growth. Potentially, owners of seven-figure rollover IRAs could leave the grandkids a growing income for life.

Just one problem: Bright, imaginative grandchildren weren’t going to let a stretch IRA dribble out payments decade after decade. They would empty the account and use the after-tax proceeds to buy a beach house, start a business, back a Broadway musical. or who knows what.

The challenge for estate planners: Create trust provisions that deterred or prevented such impulsiveness, while also complying with IRA regulations. They rose to the challenge. Now the SECURE act has made their ingenuity almost useless. Except for spouses and with certain other limited exceptions, the SECURE act eliminates stretch IRAs. Most beneficiaries are now required to empty their IRAs within ten years.

The Editorial Board of The Wall Street Journal was not amused by the stretch IRA's demise, accusing Congress of playing a dirty trick on “the 90-year-old banking on this strategy." But the WSJ conceded, "there’s a reasonable case that IRAs weren’t meant to outlive their owners by decades.”

Michelle Singletary in The Washington Post agrees. IRAs weren’t intended to be estate planning vehicles.
There is nothing wrong with trying to minimize your taxes or the tax bill for your heirs. That’s a smart money move. However, IRAs and 401(k)s weren’t meant to be used as a way to transfer wealth. They were designed to encourage people to save by giving plan participants and/or account holders — not their children or children’s children — a tax break. The loophole created by the law that has allowed beneficiaries to stretch out their tax burden was a bonus, not an entitlement that should never be touched.
I’m with Singletary. The death of the stretch IRA is timely.


Jim Gust said...

When Congress makes a promise about tax provisions, it ought to keep that promise, especially if taxpayers have acted in reliance on that promise. Congress ought not pass a major rule change that takes effect in less than two weeks, with the December holidays intervening.

What's next? The Roth IRA tax free distribution promise turns out to be too generous? Roth IRA or Roth 401(k) distributions get a means test added to them, so that the undeserving "rich" will have to pay their "fair share"? You know that is coming.

This is why the Congress is held in such low regard, they are no longer trustworthy.

JLM said...

Congress was never, ever trustworthy when it comes to the income tax. Look how they butchered the 1987 tax reform act. And yes, most likely tax-free withdrawals from Roth IRAs someday will be taxed, at least indirectly.

Jim Gust said...

You are in good company, JLM. I'm just back from Heckerling, where the resident expert on estate planning for retirement benefits, Natalie Choate, had to give three presentations on it. On the one hand, she felt that Congress should not have made the changes retroactive and should have given taxpayers more time before the changes became effective. On the other hand, she said Congress never contemplated the stretch IRA, would never have deliberately allowed it, it was taking advantage of IRS Regs. that allowed it by accident, so its demise really was inevitable.

As a policy matter, most people seem to think that ten more years of deferral for heirs is pretty generous.