Retirement accounts may soon be taking a major hit from the IRS, if Congress decides to change the rules on a tax strategy involving inherited IRAs.
Under the current rules, people who contribute to an IRA and do not end up needing the money for retirement are able to pass the account to their heirs. The money is then allowed to keep growing tax-deferred throughout the heir’s lifetime, with minimal taxes due on withdrawals.
However, the Senate Committee on Finance voted 26-0 to put an end to the ability to stretch an IRA across generations, putting trillions of dollars of legacy wealth in danger of being taxed.
Second to the home, retirement accounts are a household’s greatest source of wealth. Individuals who inherited traditional IRAs have been able to profit from one of the biggest benefits of the tax code, allowing the tax-deferred balance to continue compounding for years. The ability to transfer that wealth to second and third generations will be put in jeopardy with this legislation.
The proposed legislation comes after the Supreme Court ruled unanimously that inherited IRAs are not “retirement funds” under the bankruptcy code and are not entitled to exemption from a debtor’s bankruptcy estate.
The proposed law does not apply to surviving spouses. Surviving spouses may either roll the money over into another retirement account or spread the taxes due on the account across their lifespan.
The proposed rule would not affect Roth IRAs because taxes on those accounts have already been paid with after-tax income by the account owner. Taxes on traditional IRAs are deferred until the account owner begins making withdrawals to cover living expenses during retirement. Heirs are required to continue making annual withdrawals from the inherited account and pay taxes on those withdrawals. The new rule would dramatically speed up the pace of those withdrawals.
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