A recent proposal by President Obama would have an effect on how Individual Retirement Account (IRA) and other retirement plan distributions are taken after the account owner dies. The Treasury Green Book, which provides explanation of the President’s budget proposals, contains a proposal that could dramatically affect the estate planning strategies for those in Houston and throughout the country. The President’s proposal would “require non-spousal beneficiaries if deceased IRA owners and retirement plan participants to take inherited distributions over no more than five years.”
The proposed change would be a dramatic shift in how IRAs are handled following the account owner’s death. Under current law, for most IRAs and retirement plans (excluding a Roth IRA), you must begin taking minimum required distribution (MRD) payments each year, beginning no later than the year you turn 70 1/2 (for a 401(k) or similar plan, you can usually defer MRD payments until after you retire). There are some exceptions to this, but this is the general rule. However, after you die, your named beneficiaries must begin taking MRD payments. The rules can be tricky to understand, but generally speaking, if an IRA owner dies, then a non-spouse beneficiary must begin taking MRD payments with the required minimum amount based on the beneficiary’s remaining life expectancy. So, if the beneficiary is a child or grandchild, the MRD payments could potentially be stretched out over a long period of time, allowing the assets to continue to grow tax-deferred. This assumes that the beneficiary or beneficiaries listed are all “designated beneficiaries”, which is a tax term of art, and will generally include named individuals such as family members. If there is no designated beneficiary, then the plan proceeds may have to be distributed within five years of the plan owner’s death.
Under Obama’s proposed change, non-spouse beneficiaries of IRAs and retirement plans would be required to withdraw all of the plan proceeds within five years following the date of the decedent’s death. There are exceptions to this rule for certain beneficiaries, such as those who are (1) disabled or chronically ill, (2) not more than ten years younger than the IRA owner or plan participant, or (3) a child who has not reached the age of majority.
Keep in mind that these are proposed changes, and they are not the law yet. It is entirely possible that this proposal will never become the law. However, based on the political winds in Washington and the need for Congress to raise funds in the face of an increasing national debt, this change could be coming. If so, it would limit the effectiveness of IRAs and retirements as multi-generational estate planning tools.
It is important to note that the existing rules discussed above as well as the proposed changes may not apply regarding a surviving spouse who is the beneficiary of an IRA or other retirement plan. Often, a surviving spouse can do a rollover of the plan proceeds into his or her own IRA and defer taking any required distributions until he or she is 70 1/2 years of age. You should speak with your Houston estate planning lawyer and your financial advisor regarding your options for handling retirement plans of deceased loved ones.