Congress is also convinced this will bring in a windfall of revenue. It won’t, but that doesn’t matter to them. In fact, this will drain revenue as it will move clients to do the better, more tax-efficient planning that they should have been doing all along.
With better planning, clients’ heirs can actually end up with larger inheritances and less tax.
IRAs were never fantastic estate planning vehicles, especially the larger ones that are left to trusts. The tax rules are thorny and the trusts often did not qualify as a designated beneficiary, undoing the estate plan.
Now is the time for pro-active advisors to address these planning issues with clients so they will no longer have to worry about the uncertainty of their estate plans. Advisors can create alternative plans right now that will have long-term sustainability, without wondering what Congress will or won’t do next.
Which IRAs Would Be Affected By The Elimination Of The Stretch IRA?
Most people won’t be affected by the 10-year payout replacing the stretch IRA, because most don’t have multi-million dollar IRAs. The smaller IRAs are likely to be consumed during the IRA owner’s lifetime for living expenses and through required minimum distributions (RMDs). Since people are living longer, lifetime RMDs may exhaust much of the IRA before it even gets to the beneficiaries.
Even if a chunk of these IRAs are left over for beneficiaries, at worst, the beneficiaries can still spread distributions over the 10-year payout period, smoothing the tax bill over those years by using the lower tax brackets. This won’t have a major tax impact, and a good share of these beneficiaries probably would not have stretched these inherited IRAs over their lifetimes, which is why the official revenue projection is not accurate. These beneficiaries would not have stretched their inherited IRA funds over more than 10 years anyway.
It’s the large IRAs that will be affected most. These are the $1 million plus IRAs—the multi-million dollar IRAs. Most of these funds will be left for the next generation and would be exposed to heavy taxation under the proposed 10-year payout, especially if they are left in trust, which most large IRAs are for post-death control and protection. The tax bill can accelerate quickly if the inherited IRA funds are taxed at trust tax rates.
Most people don’t have million-dollar IRAs, but every financial advisor has clients who do. These are the clients to focus on now.
These large IRAs are often left to trusts so they can be protected for (and from) beneficiaries. Naming a trust as the IRA beneficiary can provide post-death control for beneficiaries that a client might be concerned about, including beneficiaries who are minors, disabled, unsophisticated, spendthrifts, those who might be vulnerable or those who clients worry might squander or mismanage the funds or be subject to lawsuits or other financial problems. These are all good reasons to name a trust as the IRA beneficiary. The trust can provide the post-death protection and control desired, but it may come at a heavy tax cost since inherited IRA funds held in an IRA trust can be subject to high trust tax rates (except for a Roth IRA where RMDs paid to the trust would be tax-free).