The Highway Investment, Job Creation, and Economic Growth Act of 2012 is the latest transportation funding bill. The purpose of the proposed legislation is to finance transit, highway and bridge improvements. The bill would make critical infrastructure investments across the country and create good-paying jobs by fully funding the Highway Trust Fund and the projects it supports. So what, might you ask, does this have to do with estate planning?
In order to help raise revenue to fund the projects contained within the bill, Senate Finance Chairman Max Baucus has recommended a provision that would limit the use of stretch IRAs. Funds that are placed into a traditional IRA are exempt from income taxes. When funds are distributed from the IRA to the original account owner, or to a beneficiary, the distributed amount must then be claimed as income and taxed in the year of distribution. Under current tax law, beneficiaries who inherit a traditional IRA usually have the option of stretching out distributions over their own expected lifetimes, thereby allowing income tax-deferred growth. There are some exceptions to this rule, but overall the option of stretching out an IRA provides an opportunity for many years of tax-deferred growth. Under the proposed changes, with certain limited exceptions, a beneficiary of an IRA would be required to withdraw the entire amount, and therefore pay the deferred income taxes from these distributions, from the inherited IRA within five years.
Opponents to this proposal claim that too many investors have placed funds in IRAs, relying heavily on the tax-saving provisions currently in place. In addition, opponents argue that tax policies should encourage saving and transferring investments between generations.
Those who support the proposal claim that the changes 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. Further, the original intended purpose of IRAs is as a retirement planning tool, rather than a way for wealthy individuals to pass even more wealth to their beneficiaries (who did not earn the inherited money) essentially tax free.
Many anticipate that the proposed legislation will not ultimately clear the full Senate and the Republican-controlled House of Representatives. However, it’s certainly something for investors and advisors to keep an eye on.