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What is the ‘Estate Planning Loophole’?

Posted on: July 11th, 2014
estate planningRecently proposed legislation changes prompted the coining of the ‘estate planning loophole’ term. Federal gun trust regulations are in discussion regarding the ‘gun trust loophole’, New York’s new legislation has created a state ‘estate tax cliff’, America waited until past the final hour last year in the ‘fiscal cliff’, and now taxpayers may be affected by the ‘estate planning loophole’. What exactly does it mean?

The estate planning loophole at the focus of the latest proposed legislation is the tax liability associated with inherited retirement accounts. (Inherited retirement accounts are popular on the recent agenda of lawmakers—just last month the federal court ruled that inherited retirement accounts have no federal law protection from creditors during bankruptcy.) Under current law, tax liabilities can be minimized by stretching out distributions from inherited retirement accounts over the lifetime of the beneficiary. The proposed law would impose a deadline for beneficiaries, who would need to complete all distributions within five years of inheriting the retirement account.

This five-year limit may not apply in several circumstances, such as when the retirement account is inherited by:
  • A spouse
  • A minor 
  • A special needs person 
  • An individual whose age is more or less within 10 years of the original account owner’s age
Inherited retirement accounts, defined benefit pensions, and qualified annuities would all be affected by the five-year limit if the amendments are accepted. 

Stretch IRAs have been a logical choice for individuals who want their retirement savings to continue to grow over the lifetime of a child, grandchild, or other beneficiary. These tools offered both tax advantages and the ability to pass along one’s legacy for the benefit of a loved one. If the proposed legislation passes, individuals will need to discuss other planning options an estate planning attorney and Certified Financial Planner. 
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