Lawmakers play a vital role in helping Americans save for retirement. The laws that members of Congress help put in place create incentives for certain behavior while discouraging other actions, and in the retirement context, the trend over the past several decades has moved toward greater personal responsibility. In particular, the shift from employer-provided pensions to workplace 401(k) plans and IRAs has put the responsibility to save enough for retirement in workers' hands.
One benefit of the retirement accounts that lawmakers have put in place is that they can also allow those who are fortunate enough not to use up all their retirement savings to pass the money down to their loved ones in a tax-friendly way. However, recent legislation would take away a substantial portion of the benefits that those inheriting IRAs and 401(k)s have enjoyed up to this point. With a bill already having passed the House and headed to the Senate, fears are mounting that a significant aspect of many people's retirement and estate planning is about to get taken away forever.
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What lawmakers are thinking
The threat to retirement savers comes from a bill that's intended to protect them. The Setting Every Community Up For Retirement Enhancement Act -- better known by its acronym, the SECURE Act -- includes a host of provisions that would be favorable to retirement savers. IRA contributions would be allowed past the current limit of age 70 1/2, and retirees wouldn't have to start taking required minimum distributions from traditional IRAs and 401(k)s until their 72nd birthday. Other provisions would give employers greater latitude in crafting retirement plans, including making it easier to offer annuity products and allowing employers to increase the amount that workers contribute automatically if those workers don't choose to opt out.
Yet as with everything in Washington, these benefits would come at a cost. The version of the SECURE Act that the House passed includes provisions that would no longer allow those inheriting IRAs and 401(k) accounts to use what are known as stretch IRA strategies to extend the use of retirement accounts over the course of their own lifetimes.
Losing the stretch
The way the stretch IRA strategy works is to allow heirs to take withdrawals from inherited retirement accounts using their own life expectancies. Without the benefit of stretch IRA rules, current guidelines typically require heirs who aren't the spouse of the deceased retirement account owner to withdraw all of the money from the account within five years of death. The problem with that treatment is that heirs then find themselves in a situation in which they're required to take withdrawals even if they're in the middle of their careers and have no use for the money. Moreover, with traditional IRAs and 401(k)s, the withdrawals are subject to tax, which can push heirs into higher tax brackets and create tax planning problems.
The SECURE Act as passed by the House would give heirs a bit more time to stretch out their distributions. The new rule would provide a 10-year time limit for assets to remain in the inherited retirement account.
Moreover, some experts dispute the idea that eliminating the stretch IRA would actually raise revenue for the federal government. Although it would require heirs to pay taxes more quickly on the money they inherited within retirement accounts, it would also dissuade some older retirees from making moves like Roth conversions in an attempt to take advantage of the stretch IRA provisions.
Counting on gridlock
For those who oppose the changes to the stretch IRA provisions, things look fairly bleak. Although Washington gridlock has stymied many attempts to pass legislation, the SECURE Act passed the House with broad bipartisan support and a vote of 417-3. Moreover, although the Senate has a slightly different version of the bill that it's considering independently, that version would limit stretch IRA distributions to 5 years rather than 10 years. That makes any hope for a reconciled version of the legislation that would eliminate the changes to stretch IRAs much less likely.
The SECURE Act isn't quite a done deal at this point, but the odds of its passage are high, and that's bad news for those hoping to use retirement accounts as estate planning tools. If stretch IRAs get eliminated, then it'll mean a huge shift in the way people plan for retirement -- and it'll come at a moment at which most people won't have any time to make an effective response in their financial planning.
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