Thursday, February 16, 2012

Update on IRA Legislation

I wanted to make sure that you saw this piece from Deborah Jacobs regarding potential legislation regarding IRA's.

Ms. Jacobs is a columnist for Forbes as well as the author of a terrific resource guide to financial planning titled Estate Planning Smarts.

If you are at all interested in preserving your assets for the next generation, or even making sure that your portfolios are set up in the most tax-advantaged manner, I urge you to buy Ms. Jacobs's book.

IRA's have become a very popular means of saving for retirement in large part due to their tax efficiency.

IRA holders do not need to withdraw funds until they are at least 70 1/2, which means that the investments in the portfolio are free to grow tax-deferred.  When distributions are made from an IRA, of course, they are taxed at ordinary income rates, based on the life expectancy of the account holder.

There are lots of clever estate planning techniques using IRA's that individuals can utilize to minimize the tax bite from Uncle Sam. One way that many individuals have maximized the tax benefits of their IRA's has been to change the beneficiaries of their IRA to be the youngest possible heir. This technique thus "stretches" the tax benefits of their IRA.

As Ms. Jacobs writes:

Before Congress created Roth IRAs, the term “stretch IRA” was used to describe the strategy in which a spouse, child or grandchild inherits a traditional pretax IRA and then draws out distributions (and hence tax deferral) over his or her own life expectancy. The longer the life expectancy, the smaller–as a percentage of the IRA balance–each payout must be.

With a traditional IRA the money is taxed as it is taken out of the IRA wrapper, whether by the account owner or beneficiaries. So stretching out the IRA gives the funds extra years–potentially decades–to compound tax-deferred–a wonderful investment opportunity

However, what Congress creates, it can also change.  Apparently there is a move afoot in the House to force any holder of an inherited IRA to withdraw the entire value of the IRA within five years after the holder's death.  The only exception to this new rule - if enacted - would be if the inherited IRA is a Roth IRA.

Why make the change?  Taxes.

By forcing accelerated withdrawals from an inherited IRA, or making the original owner convert their traditional IRA to a Roth IRA, the day of reckoning in terms of taxes is moved up considerably.

Let's hope this bill is not passed.  At the same time, the very fact that it has been introduced with relatively little fanfare is perhaps an indication of the subtle ways that taxes will begin to be raised in the years ahead.