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(from:http://www.cnbc.com/2016/12/28/this-money-saving-ira-strategy-could-be-toast-next-year.html)
This money-saving IRA strategy could be toast next year
Here’s how to cope without the “stretch IRA”
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Affluent savers may soon lose a big chunk of a strategy that allows them to pass on large individual retirement account balances to their children and grandchildren.
The change is part of proposed legislation called the Retirement Enhancement and Savings Act of 2016, which easily passed the Senate Finance Committee in September.
The rule change still has to pass the Senate and the House, and then be signed by the president. Nevertheless, if it becomes law, the bill would require balances in most inherited IRAs and 401(k) plans to be distributed within five years of a saver's death. One factor behind the bill's appeal is that it will generate an estimated $3.18 billion in revenue from 2017 to 2026.
Currently, heirs who inherit these accounts can take distributions over the course of their own lifetimes, meaning the balances can grow tax-deferred or even tax-free, in many cases, for decades.
There is a provision in the bill that allows beneficiaries to exclude up to $450,000 from the five-year rule, meaning that amounts in excess of that threshold would be subject to the quicker payout — and possible taxes on the distributions.
The proposed legislation pokes a big hole in these so-called "stretch IRA" strategies.
"With a stretch IRA, you give a young beneficiary the gift of long-term tax deferral," said Jeffrey Levine, chief retirement strategist at Ed Slott and Co. in Rockville Centre, New York.
Different this time
This isn't the first time the stretch IRA has been on the endangered list.
Last year, President Barack Obama proposed a similar measure in his 2016 budget. The change didn't happen.
Tax experts are a little more uncertain this time, with a Republican Congress and Donald Trump in the White House next year.
"I think Republicans have been more apt to leave the stretch IRA rules in place, but this could be used as a bargaining chip [in budget discussions]," said Levine.
For instance, in late 2015, Congress passed its Bipartisan Budget Act — along with sweeping changes to Social Security that largely did away with "file and suspend" and "restricted application" strategies.
The overhaul to the government's retirement income program was tacked onto the budget bill at the last minute and was subject to little debate. That can very well happen again.
"I could see something similar happening here, where it isn't a priority item on the agenda for the legislature and the president-elect," said Levine. "But if it's a bargaining chip, it might sweeten the pot a little for the other side."
A five-year payout of inherited IRA balances could also help fill the federal coffers if "it's used as a revenue tool," said Stephen Bigge, partner with Keebler & Associates in Green Bay, Wisconsin.
"If they want to drop tax rates under the new Congress and president, they have to find some way to fund it," he said. "By cutting the stretch and making it a five-year payout, you accelerate tax revenues."
Don't despair if you lose access to your stretch IRA, though. There are alternatives.
Wealth transfer tips
If you'd like to pass a large IRA to a nonspouse beneficiary, consider setting up a testamentary charitable remainder trust.
At your death, your IRA will pass to this irrevocable trust. In turn, the trust will distribute income to a beneficiary either over a stated period of time or for that person's life.
Your favorite charity will receive whatever is left over, but this amount must be equal to at least 10 percent of the initial market value of the assets.
If you do this, be sure to name the trust as the beneficiary of your IRA, said Bigge.
A charitable remainder trust isn't cheap to set up: It can cost $2,000 to $3,000, depending on the attorneys doing the work.
The trust will also need to file a special tax form every year and is subject to compliance rules. Depending on the complexity, that can run an additional $750 to $2,000 a year, said Bigge.
"You would think the tax savings supersedes the cost, otherwise you wouldn't do it," he said.
"With a stretch IRA, you give a young beneficiary the gift of long-term tax deferral."-Jeffrey Levine, Chief retirement strategist, Ed Slott and Co.
Another option is to purchase life insurance with the IRA money.
In this case, you would be buying permanent life insurance — which doesn't expire after a stated period — and committing more of your premium dollars toward the death benefit for your heirs, rather than building cash value, said Levine. In this case, rather than making a large upfront purchase of coverage, you're making incremental premium payments.
The good news is that your beneficiaries would receive the death benefit payout free of federal income taxes.
The bad news is that you may not be insurable when you adopt this strategy. You could very well be in your 70s, and coverage may be hard or very expensive to purchase.
Finally, there's the Roth IRA. The owner can do small conversions from a traditional IRA to a Roth, particularly if he or she is in a lower bracket and can absorb the immediate income tax hit on the converted dollars.
Even if the beneficiary is subject to the proposed five-year rule, the income coming out will be tax-free, said Bigge.
Be aware that you can only take tax-free and penalty-free distributions if five years have passed from the time when you made your first contribution to the Roth IRA.
If you die before the five-year period is up, your beneficiaries can take, tax-free, any conversions or contributions you made to the Roth IRA up to that point, excluding any distributions you had taken during life.
However, if your beneficiaries withdraw earnings before the five-year period is up, then they are taxable, said Levine.
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