Congress could end inherited IRAs for some beneficiaries

PITTSBURGH — Retirement accounts and estate plans may soon be taking a major hit from the IRS, if Congress decides early next year to change the rules on a tax strategy involving inherited IRAs that many affluent families have used to their advantage for years.

Under current rules, people who contribute to an individual retirement account and don’t need the money to meet retirement living expenses are able to pass the account along to their heirs. That money is then allowed to keep growing tax-deferred throughout the heirs’ lifetime, with minimal taxes due on the withdrawals.

But the ability to stretch an IRA across generations could be coming to an end.

The Senate Committee on Finance voted 26-0 in September to kill the “Stretch IRA” for non-spousal beneficiaries — putting trillions of dollars of legacy wealth in danger of being collected by the tax man.

“This is going to be big,” said James Lange, a Pittsburgh-based tax accountant, attorney and author. “It’s not a done deal. It’s not immediately effective. But in the past when you had a 26-0 Senate vote, the legislation always became law the next year.”

The Senate proposal will be included in a bill called the Retirement Enhancement and Savings Act, and would require beneficiaries of an inherited IRA or other qualified retirement account to pay all taxes due on the account within five years of the owner’s death.

The proposed law does not apply to surviving spouses. Surviving spouses may still spread the taxes due on the account across their life span or roll the money into another retirement account.

As it stands, the proposal includes a $450,000 exclusion, which applies to non-spouse beneficiaries. A $1 million inherited IRA would only be subject to taxes on $550,000.

The proposed rule would not affect Roth IRAs because taxes on those accounts have already been paid with aftertax income by the account owner.

Taxes on traditional IRAs are deferred until the account owner begins making withdrawals to cover living expenses during retirement.