Lawmakers play a vital role in helping Americans save for retirement. The laws that members of Congress help put in place create incentives for certain behavior while discouraging other actions, and in the retirement context, the trend over the past several decades has moved toward greater personal responsibility. In particular, the shift from employer-provided pensions to workplace 401(k) plans and IRAs has put the responsibility to save enough for retirement in workers' hands.
One benefit of the retirement accounts that lawmakers have put in place is that they can also allow those who are fortunate enough not to use up all their retirement savings to pass the money down to their loved ones in a tax-friendly way. However, recent legislation would take away a substantial portion of the benefits that those inheriting IRAs and 401(k)s have enjoyed up to this point. With a bill already having passed the House and headed to the Senate, fears are mounting that a significant aspect of many people's retirement and estate planning is about to get taken away forever.
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What lawmakers are thinking
The threat to retirement savers comes from a bill that's intended to protect them. The Setting Every Community Up For Retirement Enhancement Act -- better known by its acronym, the SECURE Act -- includes a host of provisions that would be favorable to retirement savers. IRA contributions would be allowed past the current limit of age 70 1/2, and retirees wouldn't have to start taking required minimum distributions from traditional IRAs and 401(k)s until their 72nd birthday. Other provisions would give employers greater latitude in crafting retirement plans, including making it easier to offer annuity products and allowing employers to increase the amount that workers contribute automatically if those workers don't choose to opt out.
Yet as with everything in Washington, these benefits would come at a cost. The version of the SECURE Act that the House passed includes provisions that would no longer allow those inheriting IRAs and 401(k) accounts to use what are known as stretch IRA strategies to extend the use of retirement accounts over the course of their own lifetimes.
Losing the stretch
The way the stretch IRA strategy works is to allow heirs to take withdrawals from inherited retirement accounts using their own life expectancies. Without the benefit of stretch IRA rules, current guidelines typically require heirs who aren't the spouse of the deceased retirement account owner to withdraw all of the money from the account within five years of death. The problem with that treatment is that heirs then find themselves in a situation in which they're required to take withdrawals even if they're in the middle of their careers and have no use for the money. Moreover, with traditional IRAs and 401(k)s, the withdrawals are subject to tax, which can push heirs into higher tax brackets and create tax planning problems.