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Commentary

The End of Favorable Tax Treatment for Inherited IRAs?

Congress’ next “pay-for” is not as significant as it seems at first glance.

As part of a set of retirement provisions in the Setting Every Community Up for Retirement Enhancement Act of 2019, or SECURE Act, Congress would make it harder for heirs who inherit a tax-deferred retirement account (like a 401(k) or an IRA) to shelter the money from Uncle Sam. The set of provisions enjoys wide, bipartisan support, so it’s likely to pass sooner rather than later. These rule changes may at first seem like a big change, but taking a wider view, they probably won't have much of an impact.

Congress is making this change to how heirs must take distributions (and ultimately pay taxes) on Traditional IRAs and 401(k)s because lawmakers needed to find revenue to offset the costs of other provisions in the SECURE Act. Right now, most heirs who inherit a Traditional IRA or other defined contribution account get a huge tax break because they only need to take distributions based on their life expectancy. For example, if a 40-year old inherits an IRA, his required minimum distribution is just 2.29% at the end of the year, based on his 43.6-year life expectancy. Obviously, this gives him the ability to shield his inherited IRA from taxes for a long time.

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