Lawmakers’ attempt to raise tax revenue by curtailing stretch IRAs in the bipartisan Retirement Enhancement and Savings Act (RESA) will fail, and will actually result in lost revenue, argues IRA guru Ed Slott.
“I don’t agree that eliminating the stretch IRA would produce the billions in tax revenue that Congress thinks it will,” Slott told ThinkAdvisor in a Tuesday email regarding RESA’s provision that would limit “stretches” to aggregate account values under $450,000. “In fact, it will be a revenue loser!”
Why? If the stretch IRA were eliminated, “the government would be the big loser, since this would immediately stop the gravy train of Roth conversion money flowing into Uncle Sam from older people converting large IRAs for their children and grandchildren,” Slott said.
An IRA can be “stretched” when the account owner sets a young relative such as a grandchild as a beneficiary. When the account is inherited, the grandchild can opt to stretch out the life of the account by taking a much smaller required minimum distribution, in the case of a traditional IRA, or no RMD with a Roth IRA.
“Why would a 70-year-old pay the tax to convert [to a Roth] if the grandchild’s tax-free stretch Roth IRA period could be cut from 70 years to just 5 years? It wouldn’t be worth it.”
While Congress projects “several billion in new revenue from eliminating the stretch IRA,” Slott said, “that revenue will not materialize.”
Eliminating the stretch IRA “will cost the government a fortune, but Congress cannot see that — they rarely see the long-term impact on financial issues.”
On top of Roth conversion losses, eliminating the stretch IRA “will wake people up to do the planning they probably should have been doing all along. That means more IRA money will be withdrawn and leveraged to tax-free vehicles, like life insurance, that are even better than stretch IRAs,” Slott maintains.
“In addition to being tax free, life insurance also has no complex tax rules like required minimum distributions and is a much easier and more efficient vehicle to fund a trust with compared to an IRA. This would bring in short-term cash on the up-front IRA withdrawals, but would cost the government a fortune in long-term tax revenues lost to good tax planning.”
Also, the “cry to save the stretch IRA” loses steam because “many beneficiaries don’t stretch anyway. Most of them don’t even last the five years,” Slott said. “The government is already receiving the revenue they believe this elimination will add, so in effect, they will receive no new revenue out of this.”
As he explains, Congress isn’t a fan of stretch IRAs because that’s not why the accounts were created.
“IRAs were created to help people save for their retirement years, not for their beneficiaries,” Slott says. “When the [Employee Retirement Income Security Act] law was created, Congress was worried about workers losing pensions and being broke in retirement. The IRA was created to help solve that problem.”
Congress at the time “was only worried about workers having enough and never even considered the possibility that IRAs could grow so large that there would be balances left over for beneficiaries,” he continued, and lawmakers “never imagined the IRA to be an estate planning vehicle, which it has become for many IRA owners.”
This is why Congress “is no supporter of the stretch IRA and that is why this provision to limit the stretch IRA to five years keeps coming up (with certain exemptions — under $450,000, spouses and certain beneficiaries).”
Bottom line: “While the elimination of the stretch IRA may come to pass, the silver lining may be better tax-free leveraging of IRA funds with good planning.”
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