U.S. Senate Finance Committee Chairman Max Baucus said he would back off an immediate effort to impose tougher requirements on inherited individual retirement accounts.
The changes that Baucus proposed earlier today would raise $4.6 billion for the Treasury over the next decade by requiring younger beneficiaries to pay taxes over five years instead of spreading them over their lifetimes, according to the Finance Committee. Baucus, a Montana Democrat, had wanted to use the money to help pay for a highway bill the panel is debating.
Under pressure from Republicans, Baucus said he would work with them to find replacement revenue. During the committee meeting, he didn’t provide details about alternatives.
Baucus’s proposal would curtail a tax-planning technique that allows the buildup of tax-deferred gains inside inherited retirement accounts. Currently, holders of inherited IRAs can take required taxable distributions over their anticipated lifespan.
“IRAs are intended for retirement,” said Baucus, who said the current law is being abused. “They’re being used by some taxpayers to give tax-free benefits” to future generations.
Financial advisers and tax lawyers said Baucus’s proposal would significantly alter retirement and estate planning.
Change ‘Playing Field’
“It would really change the whole playing field for retirement planning,” said Ed Slott, an IRA adviser in Rockville Centre, New York. “That would make things simpler, but it would really put a crimp in the whole legacy planning people do for IRAs.”
The proposal includes exceptions for an account owner’s spouse, beneficiaries within 10 years of age of the account owner, and disabled and chronically ill people, according to a summary by the nonpartisan Joint Committee on Taxation. Children would be exempt from the new five-year rule until they reach adulthood.
Owners of regular IRAs must begin taking taxable distributions at age 70 1/2, and they must be taken according to a life-expectancy calculation.
Baucus’ proposal would take effect for people who die starting in 2013.
Senator Jon Kyl, an Arizona Republican, said members of his party found out that the IRA provision would be included early this morning and said it showed that senators’ attempts to limit highway funding sources to items related to transportation and energy had fallen apart.
“I think we’ve lost the opportunity to have a truly bipartisan package,” he said during the committee meeting. He later praised Baucus for his willingness to find a replacement for the provision.
“Perhaps this provision and the subject can be taken up in tax reform,” Baucus said.
Depending on how the language is written, beneficiaries in some cases might be able to use rollovers into their IRAs to avoid the required distributions, said Mary Ann Mancini, who leads the private client group at Bryan Cave LLP in Washington.
Mancini said many of her clients don’t use IRAs as an estate-planning tool because beneficiaries often want to spend their inheritances.
“If you can keep it in the IRA with tax-free growth, the longer you can keep it in the IRA, people can come out with millions,” she said. “The problem is people don’t keep it in the IRA. Young people want the money.”
‘Too Much Invested’
Baucus’s proposal would return IRAs to their intended purpose as a retirement savings tool and not an estate-planning tool known as a stretch IRA, Slott said. The change, if enacted, would cause people to spend the money in their IRAs rather than leave it as an inheritance for their children, he said.
“It sounds good, but I think it’s a nonstarter,” Slott said. “There’s too much invested in the whole stretch IRA concept.”
John Olivieri, a partner in the private clients group at White & Case LLP in New York, said the change could increase the taxable income of heirs each year for five years and may push them into a higher income tax bracket, he said.
Another potential benefit to the federal government is that, because distributions would be taken out faster, there would be less time for the money to accumulate in the IRA tax-free, Olivieri said.
“Once the money is out of the account, it can no longer grow tax-free,” he said. “That’s where the government may be planning to get the most benefit from this.”