Congress is looking to take away a planning option for IRAs as it seeks more money to fund its spending.
The proposal was snuck into the Highway Investment, Job Creation and Economic Growth Act of 2012. The bill was heard by the Senate Finance Committee, and Chairman Max Baucus (D., Mont.) recommended a provision curtailing the use of “stretch” IRAs.
What is a “stretch” IRA? Say you leave your IRA, or part of your IRA, to your son and daughter. Upon your passing, they take over (separate) IRA accounts. They cannot wait until 70 ½ to begin distributions, as these are inherited IRAs. They have to begin distributions by December 31 of the year following your death, but they are allowed to reset the distribution period to their own life expectancy. This allows the opportunity to have the IRA compound – or “stretch” – over their much longer life expectancy.
Truthfully, the numbers can be astounding. Consider a 78 year-old grandfather passing a $100,000 IRA to his granddaughter, who, upon her passing, transfers the remaining stretch IRA to her son or daughter. This wealth compounding is a reason financial planners like to work with stretch IRAs.
It is of course unpalatable to allow one to decide how to distribute the monies in his/her IRA, so Sen. Baucus has stepped-in to decide this matter for you. Under his proposal, most nonspouse inheritors would have to withdraw the entire amount from the traditional IRA over a period of five years. There would be exceptions for beneficiaries who are disabled, chronically ill, a minor, or a beneficiary no more than 10 years younger than the IRA owner.
Roth IRAs would remain unchanged. Nonspouse beneficiaries must begin distributions from the Roth by December 31 of the year after inheriting, but they can draw these out over their own expected life expectancies.
Why are people concerned? Here is a statistic: approximately 40% of the stock market is tied-up in 401(k)s, 403(b)s, IRAs and similar vehicles. It is an attractive target.
