Itís Looming... How to Prepare for the Death of the Stretch IRA - Part I
|The Lange Money Hour: Where Smart Money Talks
|Click to hear MP3 of this show|
- How Does the Stretch IRA Save My Heirs Money?
- Calculating Your Minimum Required Distribution
- Why Is the Stretch IRA Likely to Go Away?
- Without Stretch, Heirs Must Pay Taxes on Entire IRA in 5 Years
- ‘A Heist of a Middle-Class Retirement’
- Death of the Stretch IRA Would Not Affect Spouses
- IRAs Less Than $450,000 Not Affected If Stretch IRA Dies
- Tax Exclusion of the First $450,000 Would Be Prorated
- Exceptions for Disabled, Chronically Ill and Minors
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Welcome to The Lange Money Hour: Where Smart Money Talks with expert advice from Jim Lange, Pittsburgh-based CPA, attorney, and retirement and estate planning expert. Jim is also the author of Retire Secure! Pay Taxes Later. To find out more about his book, his practice, Lange Financial Group, and how to secure Jim as a speaker for your next event, visit his website at paytaxeslater.com. Now get ready to talk smart money.
Dan Weinberg: Welcome to The Lange Money Hour. I’m Dan Weinberg along with CPA and attorney Jim Lange. What happens to your IRA after you die? The laws governing IRAs are likely to change in 2017, and if you have more than $450,000 in an IRA, tonight’s show is critically important for you. This is the first in a two-part series on the death of the so-called stretch IRA. Now, for many years, inherited IRAs could be stretched for the lifetime of the person who inherits them. In other words, the person could take minimum distributions and leave most of the money to keep growing income-tax deferred, but all signs point to Congress killing the stretch IRA and requiring those who inherit an IRA to pay taxes on all but $450,000 of that money within five years. Now, tonight, Jim is going to run down the current law, the proposed change and some strategies you can use to maximize your ability to avoid having Uncle Sam take a big chunk of that IRA money. Now, this issue, by the way, is covered in depth in Jim’s new book, The Ultimate Retirement & Estate Plan for Your Million Dollar IRA. It’s available free at www.paytaxeslater.com. Let’s get right to it. Good evening, Jim.
Jim Lange: There are some very important tax laws now brewing in Congress that could likely have an enormous impact on your personal retirement and estate plan, and I think that these changes are so important, and the odds of them passing are so high, that I actually wanted to do a two-hour show. So, it’s going to be one hour today, and then one hour next week on what these changes are and what they’re going to look like and, perhaps more importantly, what you should be doing about them now and what you should be doing about them after they pass, and I can’t really overstress how important these issues are, and it will be particularly important for anybody that has an IRA or a retirement plan that is more than $450,000 because this could just make an enormous difference, I mean, the difference of over a million dollars to your kids and grandkids over time if you just ignore this, and even if you don’t ignore it, it’s still not going to be a good thing.
So, what I’d like to do is to go over what the law is now, and the law now is called the stretch IRA. Then I’d like to talk about how that works. Then I’m going to talk about what I’ll call the death of the stretch IRA, which is the proposed legislation. The odds of it becoming a reality, and probably in 2017, are very, very high, probably in the high 90s, and the impact that this could have on your family is so important that I really think that this warrants your attention. So, this isn’t going to be a, let’s say, light, breezy show in an interview style; it’s going to be more of a “Here’s what the law is, here’s what is coming, here’s what you can do about it,” and again, it’s so important, and it’s also not easy. We did write a book about that. The book, by the way, is available at www.paytaxeslater.com. But right now, I’m going to concentrate on an audio description, both for the rest of this hour and the following show.
So, what we’re going to talk about is the pending legislation regarding the death of the stretch IRA. But before we can talk about the death of the stretch IRA, first we have to talk about what is the stretch IRA, because if we don’t know what we’re going to kill, then we don’t really know the impact of it. So, what I’m going to start with is, let’s assume that you are an IRA owner, and let’s assume that you go along with my basic premise, which I have given many, many times in workshops and articles in peer-review journals and in my books, which is don’t pay taxes now, pay taxes later. Don’t pay taxes now when you are accumulating money for your retirement plan, don’t pay taxes now when you are retired and you’re withdrawing money from your retirement and your portfolio, and don’t even pay taxes now after you’re gone. Pay taxes later in all three of those. Don’t pay taxes in the accumulation stage, the distribution stage and the estate-planning stage, with the exception of Roth IRAs and Roth IRA conversions. Well, I’m going to skip the accumulation stage for at least our purposes now and go to the distribution stage and the estate-planning stage.
So, if you take my advice — don’t pay taxes now, pay taxes later — in the distribution stage, what actions can you do? And let’s assume, for discussion’s sake, that you either are already 70 or you are approaching 70, and let’s even assume that you are retired and that you have to rely on your portfolio to make your ends meet, and let’s assume that you basically have two pots of money. You have a pot of money that you have already paid the income taxes on, and you have a pot of money in some type of retirement plan, an IRA, a 401(k), a 403(b), a SEP, a KIO. For our purposes, it doesn’t really matter. But the important thing is, when you take money out of your, let’s say, after-tax portfolio, or the portfolio that you have already paid taxes on, subject to some potential capital gains, essentially, you’re only taking out the amount that you need to spend. So, let’s say you need $50,000 to spend. You can take out $50,000 and your portfolio is reduced by $50,000.
The example No. 2: Let’s say that you need $50,000 to spend and you take it from your IRA or your retirement plan instead. Well, now you’re going to have to pay income taxes on that money. So now, if you want to spend $50,000, you’re going to have to take $70,000 out of your IRA or your retirement plan. That’s going to be taxable. So now, let’s assume, for discussion’s sake, that you pay $20,000 in taxes and you’re left with $50,000. Well, let’s think about it. In the first variation when you took out $50,000 from the money that you already paid the taxes on, your portfolio is depleted by $50,000. If you do it the second way, that is, take $70,000 out of your IRA, pay $20,000 in tax, you still have the same $50,000 to spend. The difference is is that your portfolio in the second variation is depleted by $70,000 instead of by $50,000 like in the first one. So, if you think about it, that extra $20,000 that you depleted your portfolio in the second example, that money, that $20,000, is forever lost and there will be no interest, dividends, capital gains, et cetera, where if you spent the money that you already paid tax on, then that $20,000 is still in your portfolio. So, the idea of don’t pay taxes now, pay taxes later, really is a determination of which assets you should spend first. So, subject to exception, first, I want you to spend what I’ll call your after-tax dollars, then your IRA dollars and then the Roth dollars are actually the last dollars you should spend because it continues to grow income-tax free for the rest of your life, the rest of your spouse’s life and the rest of the lives of your children and grandchildren.
But anyway, that is the application of “don’t pay taxes now, pay taxes later” in the distribution stage. “But wait!” you say. “Hang on! What happens when I turn 70? I might want to let my IRA continue to grow tax-deferred, but I’m not allowed to, am I? Aren’t I required to take some money out of my IRA and pay taxes on it?” And the answer is yes, you are. And what is that called? That is called the minimum required distribution of the IRA, all right? Now, by the way, hang on with me because we’re going to talk about the dying part later, but let’s do the living part first, which is probably more fun.
All right, so you now have, let’s just say, a million dollars in your IRA, and let’s assume, for discussion’s sake, that between your Social Security and your after-tax dollars, that you have other money that you could spend, and you know the more money that you withdraw from your IRA, what’s going to happen is the more taxes you’re going to have to pay, and as we saw in that prior example, we don’t want to deplete the portfolio by paying taxes earlier than you have to. On the other hand, if you have to, because you’re required to do it, you do it. So let’s assume that you say, “OK, I want to comply with the law, but I only want to take out the absolute minimum that I am required to take out.” Fine. That is known as the minimum required distribution of the IRA. So, how do you calculate the minimum required distribution of the IRA? Well, first, you go to (an IRS) publication called 590 — it’s also available pretty readily in software — and you get a factor. Let’s say, for discussion’s sake, you’re 70 years old, and depending on when your birthday falls, let’s assume that that factor is 27.4. So then, what you do is you take the 27.4 and you divide that number into the balance as of December 31 of the prior year. Let’s say it was a million dollars. Now, if you think about it, dividing 27.4, if you were to change that to percentages, if it was 25, it would be exactly 4 percent. So, since it’s a little bit higher than 25, that means the factor is a little bit less than 4 percent, and the way the math works out is your minimum required distribution is $36,396. All right, so you have to take that money out and pay income taxes on it whether you like it or not. All right, well, what happens the next year? Well, the next year, the divisor changes and it changes because the life expectancy, which is how the divisor is determined, and by the way, the life expectancy is not just your life expectancy. When you’re 70 years old, for example, the IRS doesn’t assume that you have a life expectancy of 27.4 years. To oversimplify, they assume that you are going to use the lowest number possible, and they’re going to give you a 10-year bonus, and technically, the way it works is you take a minimum required distribution based on the joint life expectancy of you and somebody deemed 10 years younger than you. Now, there’s exceptions if you have a young spouse, but let’s just stay with the main rule. So, to oversimplify again, if you’re 70, and let’s say that your life expectancy is 17 years and the joint life expectancy of you and somebody deemed 10 years younger is 27.4 years, that is your starting divisor. Then, the next year, your life expectancy goes down. Now, it doesn’t go down quite by a full year, but the divisor becomes 26.5, and then the following year, 25.6, then the next year 24.7. So basically, the factor is going down, which means the minimum required distribution is going up. Now, depending on the investment results, if you’re getting, let’s say, 5 percent or 6 percent, then notwithstanding the fact that you’re taking a distribution from your IRA, your balance is going up.
Anyway, that’s relatively common planning for a lot of people who can afford to take only the minimum out of their retirement plan, and I think that that’s actually relatively well known, even if the details are not, that people want to take the minimum of their IRA unless they actually need the money, and if you go back to my original premise — don’t pay taxes now, pay taxes later — in the distribution stage, then we’re going to take nothing until we hit 70, and then at 70 and beyond, we’re going to take the minimum required distribution.
OK, so that makes sense while you’re in the distribution stage. Well, what happens to your IRA after you die, all right? And not a lot of people really understand the essence of this, and I would say that the planning on this inherited IRA is botched, I don’t know, maybe 90 percent of the time. I don’t have solid statistics on that. I’ve actually heard statistics higher than that, but certainly way more than 50 percent. But, of course, we’re going to do this right. So first, we’re going to talk about what the existing law is right now, and then what is proposed, the chances of the proposal becoming law and how the new law will work.
All right, so what is the current law that is known as the stretch IRA? All right, so let’s say you and your spouse are dead and you leave your money to, let’s say, your child who is, let’s say, 40 years old. Your child would also be required to take a minimum required distribution of the inherited IRA, just like you were required to take a minimum required distribution of the IRA.
Now, your child doesn’t get the advantage of not having to take anything until 70. He must start taking it the year after you die. What your child has inherited now, this is a unique asset, and it is known as an inherited IRA because remember, nobody has paid income taxes on this money, and whenever somebody, whether it’s you or your grandchild or your child or anybody other than, say, a charity, makes a withdrawal from that inherited IRA, or even an IRA in your case, they’re going to have to pay income taxes on it. So, what did I say before? Don’t pay taxes now, pay taxes later. So, let’s say that your child is in the fortunate position that maybe they’re working and they don’t need a ton of money of the inherited IRA to meet their expenses. Maybe you left them some after-tax dollars, too. But with the inherited IRA, what I would recommend is that they take just the minimum required distribution of the inherited IRA. So, what they would do is they would go to Publication 590, they would find the factor, which, for a 40-year-old, is 43.6. That becomes the divisor and they divide that into the balance as of December 31 of the prior year, all right? So, it’s maybe roughly, let’s say, 2½ percent. Then the money continues to be invested, and then the following year, they have a minimum required distribution of the inherited IRA, but they have to subtract one year from the life expectancy. So, it’d be 42.6 divided by the balance. The following year, 41.6. The following year, 40.6. The following year, 39.6, et cetera, et cetera, et cetera. So, this is known as the stretch IRA, and one of the things that we’ve been doing in our practice is we love the stretch IRA and we plan for it. We do all the paperwork accordingly, and one of the things that’s really a lot of fun and just provides enormous value to the family is if we sometimes have grandchildren or trusts for the benefit of the grandchildren as the beneficiary of at least a portion of the IRA, in which they get this enormous “stretch.” So, the factor, instead of maybe being in the 40s, might be in the 70s or even 80s. That is, the grandchild’s minimum required distribution would be very small because they would take their factor, divide it into the balance, and if their factor is something like 80 or 75, then the amount that is being withdrawn is well less than 2 percent, and then, because the grandchild is much, much younger, their minimum required distributions of the inherited IRA are much, much less than the child’s, who, by the way, is still less than the surviving spouse.
So anyway, that’s basically what the stretch IRA is. Now, our office has done about 2,400 estate plans with the stretch IRA being a major, major component. Unfortunately, this enormous tax benefit we think is going to go away. This is what I have been fearing for literally years. So, in 2013, there was a vote. President Obama wanted it, the House of Representatives wanted it, and it was actually only the Senate that stopped it 51 to 49. So, I had a feeling it was coming, and I did everything I could to warn people. I felt like Paul Revere. “The death of the stretch is coming! The death of the stretch is coming!” So, I included it in my book. I included it in multiple radio shows. I wrote two peer-review articles, so if you’re one of my clients, you would have received two peer-review articles. I also actually wrote a book on it. So, I basically said, “OK, we think the death of the stretch IRA is coming. Here’s what you should do now, and then here’s what you should do when it actually passes.” All right, and by the way, that book is available at no cost. All you have to do is go to my website at www.paytaxeslater.com and you can download that book for free. So I’ve really been on top of this issue, and I have been warning against what I fear is going to happen, which is going to be the death of the stretch IRA. So, we talked in the first segment about, well, how does the stretch IRA work? All right, so, what about the death of the stretch IRA? And first, before I even get into the details, what is the certainty that this thing is going to pass? Well, in September 2016, the Senate Finance Committee voted 26 to nothing to kill the stretch IRA. In the past, when the Senate Finance Committee has unanimously voted on anything in the tax code, it goes through. It also makes sense because Congress and the IRS want money. This is an easy, easy way for them to get money. So I and the majority of the experts that I’ve spoken with truly believe that this is going to pass sometime in the year 2017, and the way the legislation is written is it will actually be applied retroactively to anybody that dies on or after January 1, 2017, and if you’re listening to this, that probably means you because you’re going to die sometime after January 1, 2017, and I’m going to assume, for discussion’s sake, if you’re listening to this program, that you have an IRA or a retirement plan.
So, the next question then is, well, what happens to the IRA or retirement plan if this new law is in effect, which I firmly believe it will? Well, let’s take away your spouse, which is an exception — we’ll get to your spouse in a minute — but let’s talk about what happens if you leave that money to a non-spousal heir, which is typically your children equally. All right, so before, remember, I said that this was a unique asset because nobody has yet paid income taxes on that asset, that the asset has this income-tax liability, but under the existing law, the heir can take a minimum required distribution of the inherited IRA over their own life expectancy, and, in effect, defer the taxes on it, which is, in effect, don’t pay taxes now, pay taxes later, even after death. Well, the proposed law would say that your heir would have to pay the income taxes on the entire inherited IRA within five years of your death. Now, think how miserable that would be. So, let’s keep the math simple. Let’s say you die with a million dollars in your IRA, and, at this point, your spouse is gone also, and to keep the math simple, let’s assume that you leave all the money to one child, all right? So, that one child, regardless of his age, subject to exception, will have to withdraw the entire million dollars out of the inherited IRA within five years. Now, assuming that that child has a job, or even if the child doesn’t have a job, what happens when you take a million dollars out of the IRA? Well, not only will that child have to pay income taxes on that million dollars, but that million dollars will likely jack that child’s tax bracket perhaps to the top bracket, and even if you’re cute about it and you take out a certain amount each year, even if you’re only taking out, say, $200,000 per year, that’s still going to put your child at or near the top of the tax bracket. So, the child could easily lose 40 percent of that IRA, and then the other question is, where are they going to get the money to pay the income taxes on the withdrawal of the IRA? If they have to go into the IRA again, that’s going to cause more taxes, and then where are they going to get that money, and it’s one of those circular calculations. I mean, we’re talking about some serious, serious misery, and we think it’s going to happen. You know, Congress and the IRS need money. This is one way that they’re going to get money, and that is again the focus of the book, and the book, by the way, is called The Ultimate Retirement & Estate Plan for Your Million Dollar IRA, including how to protect your nest egg from the pending death of the stretch IRA. And by the way, I should mention I wrote that book before the Senate Finance Committee voted 26 to 0. So, it’s one of those I hate to say I told you so, but unfortunately, I was right on that.
All right, and by the way, what do I think about it? And I guess this isn’t really a political show, and I usually just try to keep to substance rather than politics, but frankly, I hate it. I actually think that this is a heist of a middle-class retirement. So, you know, if you even have, and I’m using the example of a million, but it has an impact on anybody that has more than $450,000, and I hate to say it, but $450,000 is not all that much today. Using a safe withdrawal rate, you’re talking about $16,000 a year. So, we’re not talking about multimillionaires here. We’re talking about things that are just going to hit the middle class and basically hit the children of people who’ve worked all their lives, worked 30 years, worked 40 years, and a lot of clients, and a lot of Pittsburghers in general. So, what do Pittsburghers have? We have a good work ethic. What does that mean? Does that mean that we took jobs that paid us a zillion dollars? No. But what we did is we took jobs when we were relatively young. We were prudent, so we put money in our retirement plan. Hopefully, if we were lucky, we worked for a company that has a matching plan or will put something in for us, like if you worked at the University of Pittsburgh, for example, if you put in 8 percent, they contribute 12 percent, or if you worked for Westinghouse or PPG, or actually probably most of the bigger companies had some kind of 401(k) plan, or, in the non-profit sector, a 403(b) plan. So, even though our salaries weren’t fabulous, and we had car payments, and we had house payments, and we paid for the kids’ braces, and we paid for the kids’ college. So, it was really hard to get ahead. But we were prudent, so we always put money in our retirement plans, it was often matched, and now, you know, we’re in our 60s, 70s, maybe even beyond, and most of our money is in a retirement plan, and having more than $450,000 isn’t all that much. A lot of people have a lot more than that, and that’s who this law is going to hurt. So, they’re going to hurt the person who had been working for 30 or 40 years, diligently putting money in their retirement plan like you were supposed to, and here’s the other thing: During those years when you were putting away that money, the rule was if you died and you left that money, that IRA or inherited IRA, to your children or grandchildren, the rules at the time — this goes back to the ’80s — were they were allowed to stretch, or defer the income taxes on that money, and that might have been part of your calculation. “OK, another advantage of me putting money in my retirement plan is that the children will be able to use it, in effect, for their retirement plan. So, those are the rules. I’m going to play by the rules,” and now, late in the game, after you’ve accumulated all this money, the IRS comes and says, “Hey, no. After you die, we’re not going to let your children stretch the IRA over their lifetimes. They’re going to have to pay the income taxes in five years after you die.” So I actually think it’s horrible. I really resent it, and, you know, the idea that they’re going to completely abolish the estate tax so people with multibillion dollars can pass on multibillion dollars to their heirs without a nickel of tax, and then the middle class, who has $450,000 or more in their IRA, anything more than $450,000 is going to get whacked, and your child’s going to have to pay the income taxes on the whole thing within five years, unless they do some of the things that we are going to talk about. So, I actually think that this is a pretty miserable, miserable law. But it is going to happen.
So, I mentioned $450,000 a couple times. So, what are the, let’s say, areas of relief for this law? Well, the first very good piece of news is this will not apply to your surviving spouse. So, if you have an IRA or a 401(k) or a 403(b), et cetera and you leave the money to your spouse like most of us who are married do, the new laws won’t have any impact and we use the old law, which basically, to oversimplify, we usually recommend the surviving spouse do a trustee-to-trustee transfer, better known as a rollover. There is a technical difference. We like the trustee-to-trustee transfer into their own or a separate IRA, and they get to take minimum required distributions when they’re 70. They don’t have to take out anything like your kids, and even after they’re 70, they can use the favorable rates, that is the bonus 10-year joint life expectancy. So, if you die and leave it to your spouse, there is no real immediate impact in terms of the difference with the new law. The difference will come when the money goes to a non-spouse.
So, what is the other favorable exception? The law, at least as it is written right now, and this, by the way, came as a surprise. So, if you look at my book, the book itself does not have this particular feature that I’m talking about, which is that the IRS will allow $450,000 per IRA owner. So, let’s say, for discussion’s sake, that you die with $1.45 million and you leave it to your son. What the proposed law says is that your son can use the old stretch IRA, or inherited IRA laws, for the $450,000, but will have to pay income taxes on the remaining amount, the remaining million dollars, within five years of your death, all right? So, that becomes pretty darn important. So, if you and your spouse have a total of less than $450,000 in your combined IRAs and retirement plans and it’s not going to grow beyond that, then you probably don’t have to worry too much about what this proposed law is. But if you happen to have more than $450,000, or combined with your spouse … by the way, I can’t even say more than $900,000 for reasons that I’ll get into, just a combined total of $450,000 or more, then you have to really think about what the impact of this law is and decide what to do about it.
Let me give you at least a little bit of an idea. If you die with, let’s say, maybe about a million dollars under the old law versus the new law, and now I’m not talking about the $450,000 exception, but the difference over time could literally be the difference between … and using the same interest rate, the same spending, the same everything else, and if anybody’s interested, I’d be happy to give you all the details, but to spare you the boredom, I won’t, but the upshot of it is, in the first example where the income is accelerated and using certain assumptions, your child runs out of money at age 82. Using the exact same assumptions, except the child has the benefit of the stretch IRA or the existing law, they have $2.5 million at that same point in their lifetime. So, just think about the difference. It’s just so enormous the difference between your child being broke or your child having $2.5 million. So, this is an enormous point, and it’s even exacerbated if you’re leaving it to a grandchild. The difference literally could be the grandchild being broke, or the grandchild having, believe it or not, like $15 million depending on the assumptions. So this is really important stuff.
The exclusion is going to be an important planning component, and one of the things that is pretty tricky about the exclusion, in fact, our office didn’t quite understand exactly the way it worked until we really delved into it, is that … so, I said very simply, let’s assume, for discussion’s sake, that you have $1.45 million, you leave it to your child, and then I pretended as if your child could treat the $450,000 as exclusion and the million dollars as accelerated or the death of the stretch IRA. But it’s actually a little bit worse than that, and I’m not going to try to get too technical, but I think it is important to know that basically, the exclusion is prorated. You can’t pick and choose which $450,000 you want to stretch. So, for example, let’s say you had $1.45 million. Wouldn’t it be delightful to say, “OK, I’m going to leave the $450,000 into a well-drafted trust for the benefit of my grandchildren, and then they can take advantage of the stretch IRA over their lifetime using this exception, which is the $450,000 exclusion. Then I’m going to leave the million dollars to my children. They’ll have to pay the income taxes on five years, but at least I’ll still get this great $450,000 stretch for my grandchildren.” Well, that would be great, except you’re not allowed to do that. You have to prorate. So, what does that mean? That means at your death, you have to take all your retirement plans, your IRAs, your 401(k)s, your 403(b)s, your SEPs, your KIOs, even your Roths and your Roth IRAs, and you add them all together. Then, first, you get a, let’s say, ratio of the exclusion amount between traditional and Roth, and then, for each beneficiary, they’re going to get a certain percentage of the exclusion. So, let’s just say you had three kids, and you’re leaving all the money to three kids equally. All three kids would have the same amount of excluded from the death of the stretch IRA and accelerated, which is the death of the stretch IRA. So, we can’t play the kind of games that we might want in terms of allocating the exclusion to whoever we want. Now, the good news is that the proration does not have anything to do with going to the surviving spouse. So, let’s just say, for discussion’s sake, that you have $1.45 million, you leave a million dollars to your spouse, you leave $450,000 to your son, your son can use the $450,000 as the old rules or the existing law is regarding the stretch IRA, and your spouse can do whatever he or she wants with the million-dollar IRA, including rolling it into his or her own IRA or doing a spousal IRA, et cetera.
So, the spouse is not included in this proration, and likewise, charities and charitable trusts are not included. Now, this is a very important point, and by the way, I actually wrote an addendum on this death of the stretch IRA after the $450,000 exclusion was known, and at the time, I didn’t realize that you didn’t have to prorate with charities. So, I wrote an addendum, and if you were one of the earlier readers of the addendum, you would’ve seen, “Oh, you might have to prorate even with charity,” and it’s a very technical point regarding Internal Revenue Code Section 401A9, and I missed it and people in my office missed it, and we’re actually in the process of redoing the addendum. At least, other than that, I think that’s the only issue with the addendum. But the addendum does talk about a lot of strategies, and by the way, by the time you read this, that will have been fixed, and I’m going to recommend that you download that addendum. Again, that’s at www.paytaxeslater.com/addendum. So, what basically happens then is you do have to prorate it, but you don’t have to include the spousal share or the charitable share or — what we’re going to get to later — a share that might go to a charitable remainder trust. That’s a little hint of what are some of the potential solutions to this death of the stretch IRA. The charitable remainder trust, or it’s sometimes called a CRUT, which we would use instead of leaving it to your child, in many cases, will end up leaving more money and a greater cash flow to your child, but we will get into that. It will work for a relatively limited number of people.
Now, I’m going to skip all the math. I have a couple mathematical examples of how the proration law works, but I’m going to save you from that and just talk a little bit more about some of the exceptions from the five-year rule. So, I mentioned the spouse, all right? I also mentioned charities and charitable remainder trusts. I also mentioned the $450,000 exclusion. All right, so, what are some other exceptions? Well, they do make some exceptions for disabled beneficiaries, for chronically ill beneficiaries, for very young beneficiaries, all right, so, for minors, and it might depend on which state you are in. On the other hand, it’s not as great as it sounds because as soon as that minor is not a minor, boom, we start the five-year clock running again. The other thing is, if you have inherited an IRA already and you are stretching the minimum required distribution of the inherited IRA, or even with that $450,000 exclusion, if you die, the beneficiary of that inherited IRA, in other words, the inherited IRA of the inherited IRA, that will also be accelerated for five years. Now, there’s some special strategies that we get into with special-needs trusts, which is probably a little bit too specific for this general program, but if you have a special-needs beneficiary, whether it’s a child or a grandchild, there’s some real opportunity, and there always has been, but now, there’s even more opportunity for some sophisticated planning.
All right, so I think I’ve given you some idea of what the problem is, so just think of it from a very broad standpoint. After the exclusion, your kids are going to have to come up with income taxes on the entire inherited IRA. If they don’t have any money outside the IRA, it’s going to really just decimate your IRA that will wipe out anywhere between a third and maybe even up to a half of what you have spent a whole lifetime accumulating. I think it’s grossly unfair. I really resent it. On the other hand, rather than hiding my head in the sand like an ostrich, I’m saying, “OK, this thing is coming. What the heck should we do about it?” All right? So, why don’t we get into … let’s say that we think this thing is coming. On the other hand, at least at this point, it’s not a done deal. It’s not a certainty. And one thing that’s very important, and you hear this in the practice of medicine: First, do no harm. We do the same thing in wealth advising: First, do no harm, but let’s do things that will hopefully work out whether they change the law or not. So, that’s going to be the emphasis of what we’re going to talk about.
OK, so I think that what I have done up to now, or at least attempted to do, is to really define the scope of the problem, and then probably the next segment, or actually the entire next show, is going to be, OK, now we know what the problem is, we know how it’s going to work, what the heck should I do about it and what the heck should I do about it knowing that it’s still not a done deal? So, we don’t want to harm ourselves, we don’t want to harm our families in the event that I’m wrong and it doesn’t pass, but what should we do about it? So, what we’re going to do, we’re going to wrap up with a five-minute talk with Maury Fey and the Westinghouse SURE Group, which is my special way of acknowledging the fabulous volunteer work that they do, and then when we come in for the next show, we’re going to talk about what we should do about it.
One of the problems with listening, watching or reading the news is everything seems to be bad. We hear about murders. We hear about rapes. We hear about the deficit. We hear about shootings. We’ve just suffered through the nastiest campaign in our history. I thought I would take a minute to talk about something that’s positive, and something that is good, that we hardly ever hear about. There is an all-volunteer organization that consists of retired Westinghouse employees that just do an incredible job volunteering their time in a variety of areas. Here’s Maury Fey, the past president of the Westinghouse SURE Group to tell us a little bit about it. Maury?
Maury Fey: Thanks, Jim. I’m more than glad to talk about the Westinghouse SURE program. It began about 25 years ago, as a matter of fact, under the first President Bush’s Thousand Points of Light program. It started very small and it’s been going on ever since. We now have nearly a thousand members in this organization, and we currently are performing volunteer services in about 80 different program areas. Over the years, we have done nearly 1.2 million volunteer hours of service to these 80 and several that are no longer with us. The SURE Organization not only works in the current community arena, but we also have a very large member-service program, under which we have various social activities for the folks, an excellent newsletter that consists of 20 or 25 pages that’s produced six times a year, and furthermore, we do educational seminars, things of interest to retirees in the areas of financial planning, estate planning, health care, insurance areas, particularly health insurance. Now, coming back around to the financial area, we currently have two-hour meetings once a month. Those meetings consist of not only financial planning, but also estate planning, other legal aspects which are important to retirees. By the way, one of the folks who has been active in presenting these financial seminars is a young … well, used to be a very young attorney by the name of James Lange. That’s you, Jim!
Jim Lange: Not so young anymore!
Maury Fey: Not so young anymore, but like I said, that’s you and you’ve been extremely faithful and have been just a joy for us to work with over the years and we very, very much appreciate it. Now, I’m sure there are people amongst the roughly 50,000, maybe 60,000, Westinghouse retirees that are saying, “Gee, I think I’d like to belong to that organization.” We certainly would welcome anyone who would care to join us, but you must be either a Westinghouse retiree or a retiree of one of the surviving Westinghouse units which now belong to other companies.
Jim Lange: And Maury, let’s say that a Westinghouse employee or retiree is listening and they are interested. Could you give them contact information, a telephone number, a website or something for them to go to?
Maury Fey: Absolutely. Our website is www.westinghousesure.org. We have an address which folks can write to: Westinghouse SURE, 641 Braddock Avenue, East Pittsburgh, PA 15112. So you can reach us both ways.
Jim Lange: And I will just say that having had experience with the Westinghouse retirees for just about 20 years, I will say that they are the most honorable, trustworthy, good people, and smart and nice, that I know. So, anyway, Maury, thank you for your faithful service. Thank all of the Westinghouse retirees for their million-plus hours of volunteer services, and there, we said something good on the radio. Thank you again, Maury.
Maury Fey: You’re welcome. Thank you very much for the opportunity. Goodbye.
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James Lange, CPA
Jim is a nationally-recognized tax, retirement and estate planning CPA with a thriving registered investment advisory practice in Pittsburgh, Pennsylvania. He is the President and Founder of The Roth IRA Institute™ and the bestselling author of Retire Secure! Pay Taxes Later (first and second editions) and The Roth Revolution: Pay Taxes Once and Never Again. He offers well-researched, time-tested recommendations focusing on the unique needs of individuals with appreciable assets in their IRAs and 401(k) plans. His plans include tax-savvy advice, and intricate beneficiary designations for IRAs and other retirement plans. Jim's advice and recommendations have received national attention from syndicated columnist Jane Bryant Quinn, his recommendations frequently appear in The Wall Street Journal, and his articles have been published in Financial Planning, Kiplinger's Retirement Reports and The Tax Adviser (AICPA). Both of Jim’s books have been acclaimed by over 60 industry experts including Charles Schwab, Roger Ibbotson, Natalie Choate, Ed Slott, and Bob Keebler.
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