Congress really should let the estate tax go back to its pre-Bush levels. That way, we might get some amount of tax out of these huge estates that get passed from one generation to the next and cut down somewhat on the way the top 1% is garnering all the resources.
But along the way to that result, they need to get rid of a lot of gimmicks. Consider the Wall St. Journal's story on the Finance Committee proposal to finally end a windfall to beneficiaries of IRA accounts. Kelly Greene, Congress Eyes New Rules for Inherited IRAs, Wall St. J., Feb. 11-12, 2012, at B9.
Today, if you inherit an IRA account or a 401(k) account, you can stretch the withdrawals over your own life expectancy, while assets continue to increase in value with tax-deferral. If the beneficiary is a child, then the withdrawals get stretched over many decades, and the resulting tax deferral is a significant benefit that about equals no taxation.
The proposal would instead require heirs to take out all of the money inh inherited IRAs and 401(k) accounts within 5 years. That would allow them some ability to handle the large lump sum payout without undue taxation, but would not permit them to continue to enjoy the tax-deferral on continued accumulations. The proposal would exempt children with special needs, beneficiaries who are within 10 years of the original account-holder's age, and spouses. Those exemptions seem eminently reasonable--the spouse or special need child likely depended on that income during the marriage and should be able to continue receiving the benefits of the payout throughout his or her life, while the continued payout for beneficiaries of about the same age is most likely to cover an elderly sibling or parent (or same-sex spouse not otherwise recognized, regretably, by federal law).
The Journal article notes the concern that heirs will "blow through" their inheritance because of getting it in a lump sum. Or they will lose it in bankruptcy, since the money once paid out would lose the bankruptcy protection of the IRA.
What's worrisome is that planning for large estates would still have too many gimmicks to fall back on even with that reasonable change to eliminate a windfall to young beneficiaires of 401(k) accounts. The Journal article notes "there are still a number of ways to transfer money to your children, though they are more complicated and have costs." It lists specifically--
- Life Insurance. withdraw IRA assets you won't need, pay the tax now, buy life insurance, and fund a trust for the kids with the life insurance. That removes the funds from the estate because of the exclusion for life insurance proceeds.
- Charitable Remainder Trust. leave the IRA to a CRT--the donor gets a tax deduction, and the beneficiaries get payments
Life insurance proceeds shouldn't be tax-free: they should be subject to the same investment gain taxation rules to which annuities are subject. And Congress needs to eliminate provisions like the Charitable Remainder Trust that permits a deduction even though one's heirs receive payments. Congress should do a thorough cleansing of the Code to remove all such gimmicks, including the valuation discounts that are used to claim that an asset is worth less because it is transferred into an entity where there are 'restrictions' on transferability that discount the value.
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