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George F. Bearup, J.D. Senior Legal Trust Advisor

22-May-17

Stretch IRA Update

This past weekend I had the opportunity to speak with Nancy Welber, a fellow ACTEC member, who is on the ACTEC subcommittee that is in the process of submitting a proposed recommendation to the Senate Finance Committee on stretch IRAs. Nancy gave me an informal update on where things stand with the stretch IRA rules.

Take-Away: It still looks like the stretch inherited IRA as we know it is going away, but its replacement might look a bit different than the original 5 year required minimum distribution.

Background: You will recall that in 2016 the Senate Finance Committee submitted to the full Senate a proposed bill to shorten the required minimum distribution period for inherited IRAs from the beneficiary’s life expectancy to 5 years, but it (i) excluded surviving spouses, minors, or disabled beneficiaries from the acceleration rules;  and (ii) it exempted $450,000 of IRA assets from the accelerated required minimum distribution rules (sticking with a life expectancy payout to the beneficiary.)

This proposed change in the stretch required minimum distribution rules has created a lot of angst for estate planners as it would be a fundamental change in the required minimum distribution rules of over 30 years. Moreover, the proposed $450,000 exemption was causing heartburn for many IRA custodians for the simple reason that the $450,000 exemption was for all IRA accounts, not every IRA account. For those clients who had multiple IRA accounts, how would the $450,000 exemption be allocated among the IRA custodial accounts? How would an IRA custodian be able to calculate the excluded amount if there were other multiple IRA accounts of which the IRA custodian was unaware? How would the several IRA custodians communicate amongst themselves to identify their respective RMD’s for the calendar year, since the IRA beneficiaries might not be the same for each IRA account? In short, the logistics of identifying, and allocating, the $450,000 exemption amount among several IRAs was never addressed in the Senate Finance Committee’s proposed legislation, which prompted the bar and ACTEC to furnish comments to the Senate Finance Committee.

With a new legislative session starting in 2017 the Senate Finance Committee has had to start anew with its efforts to change and accelerate the required minimum distribution rules, which has given the ACTEC subcommittee the opportunity to come up with a suggested new proposal.

Tentative Proposal: According to Nancy, if the Senate Finance Committee is adamant in its effort to shorten the stretch inherited IRA distribution rules, her ACTEC subcommittee has come up with a simplified version of the required minimum distribution rules for inherited IRAs. That proposal would not  identify any exemption amount, simply due to all of the challenges in identifying and allocating that exemption amount over several IRAs over several different IRA beneficiaries. But the mandatory required minimum distribution period would be a flat 21 years [not 5 years as in last year’s Senate Finance Committee bill.] The thought was that if the required minimum distribution period was limited to 21 years, that would cover minors who are named as IRA beneficiaries. It might be viewed as a harsh compromise for disabled beneficiaries, but the deferral of 21 years would be a long time before the disabled IRA beneficiary had to take the distribution, and there might be a way to divert the IRA distribution to a self-settled/pay-back Medicaid qualifying trust that enabled the disabled beneficiary to continue to receive Medicaid benefits.

It should be noted that this 21 year deferral period being discussed by the ACTEC subcommittee is somewhat consistent with what noted IRA and retirement benefit guru Natalie Choate has been advocating for years: Natalie’s proposal has been a flat 20 year period of deferral before the IRA income must be recognized by the beneficiary.

Planning Thought:  Assuming that we are going to receive some type of tax reform in the next year or so, along with a modification of the stretch IRA rules, probably we need to give more thought to converting a regular IRA to a Roth IRA. There are no required minimum distributions for a Roth IRA for its owner. If a Roth IRA is inherited, the beneficiary does however face required minimum distributions, but the distributions will all be income tax free to the beneficiary. Why a serious consideration of a Roth conversion of a regular IRA may make some sense is that:

  • If the federal income tax rates are changed, with the elimination of the 39.6% federal income tax bracket, a conversion and immediate recognition of the converted regular IRA amount might be exposed to a lower marginal income tax rate; and
  • If the federal income tax brackets are widened to cover more taxable income before moving to a higher marginal income tax bracket, more of the income that is recognized on the Roth conversion might be trapped in the lower marginal income tax bracket.

Thus, there might be a smaller federal income tax paid on a Roth conversion. And for those of us who fear that what one Congress might give us today can be taken away by a future Congress, owning a Roth IRA would be a much better wrapper to hold wealth as income tax laws come and go.

Practice Suggestion: Due to the prospect of a mandated acceleration of required minimum distributions from inherited IRAs, or the possibility of an exemption amount associated with inherited IRAs subject to accelerated required minimum distributions, each Durable Power of Attorney that an IRA owner has in place should give the Agent the authority to convert a regular IRA to a Roth IRA, either to respond to lower income tax rates or widened income tax brackets, or the authority simply to convert a portion of a regular IRA to a Roth IRA to reduce the regular unconverted IRA balance to an amount equal to the exemption amount (if one becomes law). This same delegation of authority given to the Agent should also include the authority to re-characterize the Roth IRA to a regular IRA if the value of the Roth IRA falls after the conversion. In short, Durable Powers of Attorney should be reviewed to see if there is sufficient authority granted to the Agent to address the impact of these possible tax law changes and the response to those tax law changes to best serve the IRA owner and his/her beneficiaries.