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Stretch IRAs Under Fire

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Retirement industry officials are gearing up to remove a provision in Senate legislation that would reduce the value of inherited IRAs.

The provision is included in S. 1813, the Highway Investment, Job Creation and Economic Growth Act.

William Sweetnam, a member of the Groom Group and a former top Treasury Department official during the Bush administration, said the provision is likely to be removed, and replaced with one that raises the funds being sought by changing the way assets are valued in defined benefit plans.

He said they are known as “stretch IRAs,” and are sometimes used to reduce taxes by people who designated a young person as the beneficiary, thereby giving them a long opportunity to increase the value of the IRA through inside buildup.

It was added to the highway bill by Sen. Max Baucus, D-Mont., chairman of the Senate Finance Committee, on Feb. 7 during markup of the bill by his committee.

The bill is now awaiting floor action, and the Financial Services Institute, the Insured Retirement Institute and the National Association of Insurance and Financial Advisors are all seeking to mobilize their members to have it removed from the bill.

As currently stated in the bill text, the provision would no longer permit tax-deferred stretches of IRAs for beneficiaries other than a spouse, minor children or the disabled.

Others, like adult children, would only be permitted a five-year window to defer.

He wanted to use the money to help pay for a highway bill the panel is debating.

According to budget officials, the provision would raise $4.6 billion over 10 years.

Industry officials said the proposal would reduce the value of a tax-planning technique that allows inside buildup of tax-deferred funds inside inherited retirement accounts.

At the markup where the provision was added, Baucus said, “IRAs are intended for retirement.”

He charged that the current law is being abused. “They’re being used by some taxpayers to give tax-free benefits” to future generations.

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The FSI said in a letter to members that Baucus has apparently backed off from supporting the provision. “While we expect the provision to be removed from the highway bill, it is important that we send the Senate the message that taxes on inherited IRAs should not be used to pay for other governmental spending,” FSI officials said.

In a statement, IRI president and CEO Cathy Weatherford added in a letter to members of the Senate that “While IRI applauds the efforts of the United States Congress, a highway bill is the wrong vehicle for such a significant tax increase on retirement savings. We request that you oppose inclusion of these provisions in the final bill.”

Weatherford said in the letter that “Today’s workers face unprecedented retirement income challenges – challenges that simply did not exist in earlier generations.”

She said that the shift from defined benefit to defined contribution plans, longer life spans, and the rising costs of healthcare are among the challenges that will put more of the burdens on saving for retirement on the shoulders of American workers.

“We believe these important issues should only be addressed after more extensive study and debate,” Weatherford added.

Sweetnam said that the provision is widely used by those who engage in estate-planning – in other words, those who will be subject to estate taxes.

But, he also defended Baucus’ intent.

He said that under the current proposal, spouses, minor children and disabled children would still be able to retain the benefit of the long-term inside buildup.

Only grown children, for example, would be affected, “and from a public policy standpoint, they are the people who would get the least sympathy for being forced to accelerate their taking out funds from the IRA.”

Meanwhile, NAIFA said it is “concerned” that this proposal would have an unintended harsh impact on middle-income Americans who are struggling to save enough for retirement on their own.

Lillian Vogl, counsel, federal relations at NAIFA, gave this as an example:  “A NAIFA member told me about a 49-year-old elementary school teacher he worked with last year. She is divorced, two kids going to college with Pell grants, and only about $10,000 in retirement savings of her own. She inherited a $100,000 IRA when her mother died. Under current law she only has to take out a couple thousand a year, and most of it remains for her own retirement.”

Vogl said the five-year forced payout would cost this teacher at least $3,000 a year in additional taxes, probably disqualify her kids from their financial aid, and that money wouldn’t be there when she retires. “That is not the intended impact for middle-market Americans.”