Structuring an estate plan to account for taxes can be a complex task. While state and federal estate taxes make up the majority of discussion about taxation, there are other issues to consider. For example, there are ways to structure disbursement of various assets–insurance policies, retirement accounts, and more–so that Uncle Sam takes as small a bite as possible.
Adding to the complexity is the fact that laws frequently change which either open up more opportunities or take away previously available tax-saving options. For example, last week Forbes discussed a U.S. Senate vote that may eliminate a commonly-used tax strategy.
For years many families have created stretch IRAs. This refers to the process of naming a child or grandchild as beneficiary of the retirement account. Then, the younger individual is able to withdraw from the account in small pieces over the course of their lives. In so doing, the account is able to grow for a significant period of time without being taxed. The account is still taxed eventually, but over the course of the heir’s lifetime they ultimately pay far less as a percentage than if they would if given it all in a lump sum and taxed immediately.
Loophole Being Closed?
However, the ability to use a stretch IRA may be on the way out. That is because U.S. Senators passed a bill recently to eliminate the ability to drag out an inherited IRA withdrawal–supporters of the measure referred to the stretch IRA as a “loophole.” Specifically, per the terms of the legislation, most retirement accounts would be required to be completely distributed within five years of the owner’s passing. Spouses would be excluded from this rule, as would disabled heirs. Minors would be able to spread out disbursements until they turned twenty six years old, even if that was longer than five years.
Of course, the fact that the Senate passed the bill does not mean that it is a done deal. House Republicans may be opposed to the bill, which would kill its chances. It is unclear right now if they do, but similar changes have received bipartisan support in the past. President Obama supports the IRA-change and would likely sign such a bill if it made it to his desk.
In any event, the proposal should be watched closely by those who plan to use a stretch IRA as part of their tax-saving strategy. There are various alternatives that might be worth pursuing in lieu of a stretch IRA. The Forbes article offers an overview of some of those options. The best resources, however, are professionals like estate planning attorneys and tax advisers who can explain what makes the most sense in your specific situation.