Potential Elimination of the IRA “Stretch”

Submitted by Herm Brames on Thu, 2016-12-29 16:02

Ed Slott has become famous for his preaching about the desirability of investors use of the ROTH IRA, for among other benefits, the ability of ROTH owners to provide beneficiaries of those ROTHs the ability to “stretch” those inherited funds over their lifetime.

1) With the possibility/probability of that “stretch” benefit on life support, what advice does he now suggest we begin to consider for those of us who have followed his advice and accumulated thru purchase or conversion substantial ROTH assets with the expectation that our beneficiaries could stretch those remaining assets over their lifetime rather than having to remove those inherited ROTHs over 5 years if Congress approves legislation proposed and approved by the US Senate Finance Committee?

2) Is there any organized effort that anyone is aware of to educate/lobby Congressional members to not approve such proposed legislation and is there any DRAFT letter anyone has composed presenting cogent arguments opposing approval of the proposal?

I have always viewed the ROTH “stretch” possibility as the average person’s “trust alternative” without the costs involved in establishing and administering of a trust which may more often be the avenue for wealthier individuals to pass on assets to others.



Submitted by Bruce Steiner on Thu, 2016-12-29 18:07

 

  • Our clients generally provide for their children in trust rather than outright, to keep their inheritances out of their estates, and to protect it against their creditors and spouses, and Medicaid.  They do this for IRA benefits as well as for other assets, for the same reasons.
  • The workaround for the possible repeal of the stretch would be to leave the IRA benefits to a child (or other nonspouse beneficiary) in a charitable remainder trust.  This was a common technique before the proposed regulations were overhauled in 2001 for clients who had elected recalcuation and didn’t have a spouse beneficiary.
  • It’s an imperfect workaround because it’s less flexible, and because the payments to the trust have to go to the beneficiaries outright, thereby gradually losing the protections of the trust.
  • Bruce Steiner, attorney, NYC, also admitted in NJ and FL

Submitted by Chuck 2009x on Sun, 2017-01-01 09:56

  • I had to bullet this to get it to appear readable.

 

  • I’ve unfortunately been in the position of doing a lot of research on this in the past 24 hrs. My mother has a large IRA, and I am one of two beneficiaries and I expect theinheritance will occcur in the next two or three years. I have been helping her fix a couple of things regarding her estate planning, and I thought I had everything wrapped up until yesterday, which was the first time I had heard of this. Note that if you go to any of the financial services company websites that have beneficiary RMD calculators, probably unsurprisingly, they make no mention of this.

 

  • My understanding of the overall context is this: A couple of court rulings in IRA tax cases several years ago opened the door for legislators to end the stretch ability. Legislators want to expand the availability of tax-deferred retirement savings devices, but that necessarily reduces tax revenue. Since they want (or are required, not sure which) to be “revenue-neutral,” they have to make up the revenue somewhere else. Voila. The end of stretch for non-spousal beneficiaries (with a few exceptions).

 

  • The provision to do this currently has bi-partisan support, in fact, the latest version, S. 3471 passed the Senate Finance Committee unanimously 26 – 0. It is likely dead for this Congress and would have to be reintroduced next year. Beyond that, it would have to also go through the House. Killing the stretch IRA has been around for at least 4 years as riders to other bills, and always either got removed, or was part of an Obama budget bill, none of which Congress ever passed.

 

  • The current version S. 3471 includes a $450,000 exemption – the first $450,000 of combined IRA assets can still be stretched. This is new, and likely a compromise designed to make passage easier. Now that this provision has been shunted off into its own bill, rather than being attached to something else, it’s just a matter of how high a priority the whole bill is. I think the best hope is to get the exemption amount increased, but I’m sure it was arrived at by saying, “find a level where only X% of IRAs are larger.” So there’s probably not a huge lobby out there to increase the exemption, which already went from $0 to $450,000.

 

  • One issue I see is promulgating the infrastructure to enforce it. People can have IRAs scattered all of the place, none of which know about the others. No idea if/how that would affect passage and implementation. The two most common workarounds I’ve seen mentioned are buying life insurance, and charitable remainder trusts (CRUT). The problem with life insurance can be age (the premiums are huge if you can even get a policy), and the problem with the CRUT is, while it can be structured to mimic a life expectancy RMD, the risk is that the beneficiary dies early, in which case the remaining assets go to the charity instead of the beneficiary’s spouse (or other sub- beneficiary). I have seen various “break-even” ages or distribution periods for this.

 

  • I have just started a spreadsheet for my own case to see what the overall impact of all of this will be. The comparison has to be a smaller RMD under today’s rules minus taxes vs the forced front-loaded large distributions minus taxes, and what that larger sum can return invested a non-tax advantaged account. I hate what I see so far. It is dramatic.

 

  • My gut feeling is that Roth conversion, even if it was left alone, is not a good option (for large accounts, and this late in the game where we may be on the threshold of passage of a bill) when the IRA owner is single and the beneficiary is married, which is often going to be the case. I haven’t run the numbers on this.

 

  • I can think of two cogent arguments, both of which I’m sure have been considered, but the case can be made anyway:

 

  • 1. Doing away with the ability to stretch forces a select group of people into behavior that is the direct opposite of what the rest of the bill tries to achieve. It essentially robs some people of the ability to do what it expands for others. This is fundamentally unfair. And since it is specifically labeled as a “Payfor” and an “Offset” (ie. it pays for other things) in committee documents, it is impossible to characterize it with a straight face as anything other than a money grab.

 

  • 2. It is one hamburger today instead of a hamburger a month for life. Consider that the future impact is the same for the government as it is for the affected individuals. Under the right circumstances, the current stretch ability potentially provides an income stream for generations, to the individual AND the government.

 

  • If the bill is reintroduced in the new Congress, I assume there will have to be hearings and an opportunity to comment. I have set up Congress.com alerts on S. 3471 in case anything happens with it in the next few weeks (which I doubt), and have set up Google News alerts for “Stretch IRA” (and will probably set up additonal variations on that theme) so I will be able to find the bill when it is reintroduced. It is certainly worth a try to get more favorable treatment.

Submitted by Chuck 2009x on Sun, 2017-01-01 12:02

I completed a basic spreadsheet.

  • Assumptions:
    • $725,000 (half of the current value) Inherited IRA at age 60, life expectancy is 25 years.

    My share of the exemption is $225,000, so $500,000 must be distributed in the first 5 years.

  • $100,000 is forced distribution in each of years 1 – 5
    • The stub of $225,000 plus its earnings in years 1 – 5 is allowed to be distributed on life expectancy beginning in year 6.
    • Taxes at ordinary income rates are deducted, based on a starting base AGI (before the IRA distributions) of $65,000 AGI the first two years and $50,000 thereafter (my expected AGI considering salary and/or other retirement distributions)
    • In years 1 – 5, from the post tax remainder, an amount equal to the life expectancy RMD is retained and the rest invested.  All investment methods return 2.5% dividend and 2.5% capital appreciation annually.
    • In years 6 – end (when the RMDs from the $225,000 stub kick in), investments are sold to make up for the difference between the samller stub RMD and what the RMD would be the “old” way.  This implies a 10% cap gains tax, which I actually didn’t bother to include.  Let’s just say I eat that.
    • Result: The sum of the invested distributions from years 1 – 5 are fully depleted by the artificial “makeup RMDs” in Year 15, meaning at that point there is nothing left to make up the difference between the RMD amount the old way and the smaller one generated by the $225,000 stub.
    • The difference (all after tax) in the sum of the smaller distributions in years 16 – 25 is $382,000.  That’s half the cost of this bill for the account as it stands today.
    • Other fun facts:
    • Total Gross RMD:
    • Old: 1,471,000
    • New: 965,000
  • Total after tax RMD from the IRA:
  • Old: 1,167,000
  • New: 785,000
  • Taxes Collected
    • Old: 303,000
    • New (including taxes on divs from non-sheltered investment from the forced distributions): 194,000

     

    Submitted by Ben Meyer on Sun, 2017-01-01 18:30

    • Very nice posting.  Thanks, hbrames, for bringing up this topic, and also Chuck2009x, for your analysis, and also Bruce and Alan.  There has been very little press reaction about the RESA bill, S. 3471.  It appears that the bill did not pass, this time.  However, it will probably be back in some form since it has the unanimous support of the Senate Finance Committee.  The current bill has been carefully crafted to give out some amendments that are desirable, such as abolishing the age limit ot 70 1/2 for making traditional IRA contributions, and reinstating tax deductions for volunteer firefighters and ambulance responders.  These two amendments would be favored by the public.  But the bill also includes the end of the stretch distributions for all IRAs, both traditional and Roth, for total defined contribution inheritance plan ownership over $450,000.
    • Under the terms of the bill, exceptions would be made for certain beneficiaries, and the stretch would still apply for these individuals.  The exceptions apply to such persons as a surviving spouse, minor children until reaching the age of majority, disabled or chronically ill beneficiaries, and any other beneficiary “who is not more than 10 years younger than the employee [account owner]”.
    • This bill makes the earlier advocacy of the benefits of IRAs and other defined contribution accounts seem like a “bait-and-switch” tactic.
    • See my earlier posting with some further details:   https://irahelp.com/forum-post/27780-resa-introduced-us-senate
    • For valuations of the total of ALL DEFINED CONTRIBUTION PLANS of an individual person over the threshold of $450,000, a new distribution regimen will be placed into effect requiring a full distribution within five years of the date of death, except for the exceptions mentioned above. Where multiple accounts are held, the amount exceeding the $450,000 limit will be “allocated” across all accounts in accordance with regulations that will be established.
    • The current RESA bill does not provide for indexing of the $450,000 threshold for inflation.  Without indexing, the new regimen would affect increasing numbers of people over the years.  Annual corrections will eventually be needed as with the AMT, but might face difficulty in becoming enacted.  A decade or so into the future, the threshold will affect a very great number of persons, most of whom would not be considered “rich”, but merely good savers.
    • This proposal seems to be a good recipe for chaos.  After regulations are released, all plans will need to be amended to conform. A high degree of complexity will result, and the burden may well fall to the beneficiaries to determine the total value of all plans of a decedent, in order to know the amount exceeding the threshold for the five year distributions. Each plan custodian or administrator can’t know the total value of all plans, since each plan cannot even be aware of the existence of all other plans of the decedent. Frequently, the beneficiaries of an individual likewise have no knowledge of any other beneficiaries or plans. Since all defined contribution plans of one person are aggregated together in this new regimen, the scope of regulations would need to be extensive and would need to extend to issues never before addressed. Implementation would seem to require a lengthy transition period, which is not accounted for in the pending bill. Therefore, I believe that much confusion and complexity would be the expected result.
    • A very real question now arises as to what approaches should be taken to best benefit a beneficiary.  If not a stretch Roth IRA, then what would be the thing to implement?

    Submitted by Alan - IRA critic on Sun, 2017-01-01 17:45

    • Thank you for posting these interesting observations and projected results.  In the way of additional background used to justify ending the stretch is the Clark v. Rameker decision in 2014 which concluded that inherited IRAs do not function as retirement funds for various reasons. The arguments are included here:  https://www.supremecourt.gov/opinions/13pdf/13-299_6k4c.pdf
    • Another point to be considered in contesting these bills is all the incentives provided to induce Roth conversions in 2010. Leaving a Roth IRA to children provides many years of tax free growth despite the RMDs on inherited Roths. Now, just 6 years after $65 billion of Roth conversions were done in 2010 generating huge tax bills, the stretch benefits of inherited Roth IRAs are under fire.
    • Because of varying regulations affecting the calculation of inherited IRA RMDs, IRS enforcement of current RMD regs is incomplete and ineffective. While further clarification was supposed to be forthcoming, nothing has been issued since Notice 2003-3. Form 5498 issued to beneficiaries contains only the year end FMV of the inherited IRA, not the actual RMD amount for that account. As you indicated, while a dollar exemption would be helpful for beneficiaries of modest IRA accounts, the added complexity of dealing with pro rated exemptions will present real issues for taxpayers and the IRS. 

    Submitted by Alan - IRA critic on Sun, 2017-01-01 19:27

    To clarify, IRA accounts are not DC plans, but for purposes of the 450k exempted amount the bill states that IRAs are to be treated as DC plans. Now consider a retiree who has two DC plans, a couple TIRAs and a couple Roth IRAs with different combinations of beneficiaries designated on these plans. Calculating RMDs would be mind boggling considering the parties involved in “coordinating” the RMDs. IRS and EPCRS will need Rubic’s cube training!  :). Before these proposed bills are introduced, does anyone consult with the IRS?

    Submitted by Chuck 2009x on Mon, 2017-01-02 14:08

    • I’m trying to run some numbers on CRUTs and seem to be having a hard time finding an understandable answer to this question, although there’s only one answer that seems to make sense.  The reason I say that is because I ran numbers as if the CRUT distribution was taxable as oardinary income to the beneficiary, and there’s no clear benefit.
    • Is it correct that a distribution from a CRUT is not taxable to the beneficiary, but instead, the CRUT itself pays tax on its own income and capital gains?
    • Example, a CRUT is structured in a way so that the distribution to the beneficiary in the first year happens to be $100,000.
    • It has dividend income of $35,000 and must sell stock and incur capital gains to fund the remaining $65,000
    • Is it correct that:
    • The trust has the tax liability on the dividend and capital gain (in some order of priority)
    • The trust is in the $35,000 income tax bracket (or is it $100,000)
    • The distribution of $100,000 is not taxable to the beneficiary
    • If all (or most) of that is correct, is it correct that there some offset to the trust’s tax liability due to the fact that it must invade principal in order to fund the distribution?
  • General answers welcome, I wouldn’t want anyone to get too far into the weeds on this.  Just trying to prove to myself whether it is or isn’t a no-brainer to to pursue it.

    • Submitted by Bruce Steiner on Mon, 2017-01-02 17:43

    • The charitable remainder trust (CRT) is tax-exempt.  So if the stretch is eliminated, you can get a similar result by leaving the IRA to a CRT.  The CRT can receive the entire IRA all at once with no current tax.  Each year’s distribution from the CRT is taxable to the recipient on a worst in, first out basis.  In other words, distributions are first ordinary income to the extent th trust has ordinary income (current or accumulated), and then capital gain.  In the case of a CRT receiving IRA benefits, it’s simplest to assume that all of the distributions from the CRT will be ordinary income, though at some point it’s possible that all of the ordinary income will have been carried out and some of the distributions may be capital gain.
    • The other use of a CRT is to defer the tax on the sale of an appreciated asset.  You can contribute an appreciated asset to a CRT, and the CRT can sell the asset without a current capital gains tax.

    Submitted by Chuck 2009x on Thu, 2017-01-05 12:52

    • Thank you.  I’m think I’m still missing a piece of the puzzle.
    • Let’s say the starting assets in the CRUT are $500,000, in a stock portfolio
    • The portfolio receives $10,000 in dividends during the year.  For the sake of argument, say the capital appreciation of the stocks was exactly zero.  it finishes the year with a total value of $510,000
    • The CRUT calls for a 10% payout, so the payout will be $51,000
    • It has to sell $41,000 worth of stock at no gain or loss to combine with the $10,000 in dividend income to distrubute to the beneficiary.
    • After the distribution, the assets in the CRUT are $459,000.
    • What is the tax liability to the beneficiary on the $51,000?  Ordinary income on 10,000 and zero on the rest?  Ordinary income on all of it?  Something else?

    BTW, I have drafted a letter to send to members of the Senate Finance Committee as well as my own senators and my congressman.  I’m not sure what the best time to send it will be, but if anybody would like to see it, email me and I’ll send you the text.

    Submitted by Bruce Steiner on Thu, 2017-01-05 20:24

    • In the case of a CRT created to replicate the stretch (if the stretch is repealed), the $500,000 of starting assets will be the IRA benefits.  So if the CRT has $10,000 of dividends and distributes $50,000, the CRT will have $510,000 of income, of which the distribution will carry out $50,000.
    • If you instead contributed $500,000 worth of appreciated stocks, the CRT would have to sell some of the appreciated stocks in order to make the distribution.  So the distribution would carry out dividends and capital gains.
    • Perhaps if you contributed $500,000 worth of appreciated stocks but one of them went down in value so that at the time the CRT sells it, there’s no capital gain, then it would be possible to make the distribution without carrying out anything besides the $10,000 of dividends.  But that’s not a realistic example.  The reason you would contribute appreciated assets to a CRT is so the CRT can sell them without current capital gains tax.
    • You wouldn’t contribute to a CRT assets that didn’t have substantial appreciation.
    • Bruce Steiner, attorney, NYC, also admitted in NJ and FL

    Submitted by Chuck 2009x on Thu, 2017-01-05 21:30

    OK, I think that makes it clearer.  Wow, I guess I have been barking up the wrong tree.  While the portfolio is in the IRA it has no cost basis.  I wonder why I see mentions of CRUTs as beneficiaries of IRAs as a workaround for this problem. Maybe at different asset levels than mine it would work.  I was running numbers as if all the annual distributions to me from the CRUT would be taxed as ordinary income and it just never had any advantage other than the charitable deduction.  10 or 12 or 15 or 20% annual distributions all came out to have about the same total net of taxes after 20 years, and it was the same as the total amount over 25 years under RESA.  Plus the added risk that I die early and pass on nothing.

    Submitted by Bruce Steiner on Thu, 2017-01-05 23:19

    • If the stretch is repealed, and you have to withdraw the entire traditional IRA within 5 years, you’ll only have the value of the IRA net of taxes.  By leaving the IRA to a CRT, even though the distributions from the CRT will generally be taxable, you’ll get the benefit of deferral.  The benefit of the deferral may offset or even outweigh the eventual loss of the balance of the trust assets at your death.  
    • Note that the actuarial value of the charity’s interest as of the inception must be at least 10% of the value of the trust as of the inception.
    • This is likely to become a common workaround if the stretch is repealed.

    Submitted by Herm Brames on Mon, 2017-01-09 19:56

    Chuck, please send me a copy of your DRAFT.  Would you mind sharing a copy of your letter on this site for others to consider? One additional question for Alan, Bruce etc, If the numbers (total of IRA and # of beneficiaries) were the same as Chuck’s original post, but the IRA was a ROTH, would the suggestion for dealing with elimination of the “stretch” be the same? I’m aware that any legislative bill proposed by Congress can be ammended at any time prior to the final vote but has anyone posting here read the entire Bill proposed and passed by the Senate Finance Committee and does it allow for “grandfathering” existing IRA’s under current regulations?   Alan mentions the encouragement Congress provided in 2010 to convert to ROTH’s  Congress provided incentives as early as 1998 by encouraging 1998 conversions to ROTH’s with taxes to be paid in equal installments over 4 years.  I converted all taxable IRA’s owned at that time and after retiring and rolling over my 403-B to TIRA’s, converted all over the next 13 years to ROTH’s.  When I consider the Federal Income Tax I paid on all those conversions with the expectation of a “stretch” for beneficiaries, some might call me a SUPER SUCKER! 

    Submitted by Bruce Steiner on Mon, 2017-01-09 20:12

    • I think the analysis would be the same.  The CRT would give you the effect of a stretch.  Distributions from the CRT would carry out the trust’s income to the extent the trust had income, and then would be tax-free.
    • If the stretch is eliminated, we’ll look at this more closely, since it will affect lots of people with large IRAs, both traditional and Roth.

    Submitted by Chuck 2009x on Mon, 2017-01-09 20:36

    • hbrames, I will send you a copy of the draft letter.  I think I will tweak it a little more, to cool it down a tad, but not much.  It’s not useful to post it here because it can’t be suitably formatted.  Also on your question of grandfathering – at least as it applies to non-spousal beneficiaries of non-Roth IRAs – the latest version of the legislation, RESA 2016, called for its provisions to take effect with deaths on Jan 1 2017 or later.  That bill died with the end of the 114th Congress, we are now in the 115th and the bill will have to be re-introduced.  I don;t know whether to expect the new bill will be written to take effect on Jan 1, 2018, or upon passage, or retroactive to Jan 1, 2017.  Most bills have grandfathering of some sort.  So there’s a ray of hope that there just keeps being other higher priorities and that this just keeps getting kicked down the road and the effective date pushed out.
    • bsteiner, I keep circling around this question, but I can’t seem to resolve it – if a CRUT distributes more to the beneficiary each year than it has in income, is that excess (which represents a drawdown of principal in the CRUT) tax-free to the beneficiary?

    Submitted by Bruce Steiner on Tue, 2017-01-10 13:41

    • The excess is principal, but in the case of a traditional IRA, the principal is taxable income.  The benefit of the CRT is that it provides a result similar to the stretch.
    • If the stretch is repealed, this will be a common technique, and lawyers will dig out their pre-2001 documents.

     

    Submitted by Ben Meyer on Wed, 2017-01-11 01:11

    • To respond to the question of grandfathering, the RESA bill that expired with the old Congress did not have any grandfathering provision.  It was going to become effective immediately, to apply to a total balance over $450K of all IRA accounts and defined contribution accounts of a decedent and would have applied to deaths starting in 2017, immediately.  The threshold of $450K was not indexed for inflation.  Certain persons were exempted, such as a surviving spouse, minor children until reaching majority, disabled or chronically ill persons, and someone who is not more than ten years younger than the decedent.
    • I’m also preparing a draft of a letter for use in case the bill is introduced again.  There are many points to be made, including the basic unfairness (“Bait-and-switch”) and the unworkable complexity.  It is quite likely that the bill will be introduced again in some form.  It would be good to coordinate a response, but this forum may not be the right place.  Without a well-planned protest, the bill may well pass, since it also includes several beneficial provisions, such as allowing contributions to traditional IRA plans after age 70 1/2.

    Submitted by Chuck 2009x on Wed, 2017-01-11 21:16

    • If it had passed in 2016 and wasn’t effective until 2017, that’s grandfathering.  If it passes in 2017 and isn’t effective until deaths in 2018, that’s grandfathering.  If it passes in 2017 and is retroactive to deaths on/after Jan 1, 2017, that’s STILL grandfathering in everybody who died before Jan 1 2017.
    • The trick in raising objection is twofold, timing and finding.
    • Congress is probably going to be consumed for a couple of months with other stuff, which maybe argues for waiting for that stuff to die down.
    • On the other hand, it was only in 2016 that this provision got stuck in a bill dedicated to retirement issues.  It’s easy enough for them to cut and paste it into any other bill and you’ll never know unless someone picks up on it.  That would be an argument to make contact now.

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