Senator Max Baucus (D.-Mont.) has proposed to force most taxpayers who inherit individual retirement accounts, 401(k) accounts and other retirement plan benefits to withdraw (and pay income taxes on) all of the inherited accounts within five years of inheriting such an account. The proposal was attached to The Highway Investment, Job Creation and Economic Growth Act Of 2012, but then was taken out in committee. Sen. Baucus has vowed to attach it to a future bill. Generally, an age difference of more than 10 years between the deceased account owner and the beneficiary will mean withdrawing and paying income taxes on the entire amount inherited within five years. Surviving spouses and certain other special classes will be able to take distributions over life expectancy (as they may do under present law).
Bad idea. The Association of American Retired Persons, as well as advocates for domestic partners, should mobilize.

Ten Reasons to Just Say “No”
1. It’s a death tax on the middle class. Sen. Baucus has stated that the reason for this change is that retirement accounts are being used as estate-planning devices. A tax specifically aimed at estate planning and that’s occasioned by death is an estate tax by any other name. This is effectively an estate tax aimed at the middle class who often only have two assets to pass on at death: an IRA and home equity. Except they no longer have home equity.

2. The fact that retirement plan concepts are “hard to understand” (translation: the proposed change won’t be met with much political cost) isn’t a valid reason to create such a tax. What will be understandable is that you just made it harder for me to pass on what little value I have left to my kids.

3. It discriminates against domestic partners (whether registered and whether of opposite gender) and tends to increase the government’s support burden by doing so. The age difference in many cases will be more than 10 years.

4. Some individuals leave their IRA to a sibling who isn’t financially well-off. Taxing a sibling in that situation immediately tends to increase the government’s support burden. The age difference in many cases will be more than 10 years.

5. Most individuals die after reaching age 70 (the reason why term insurance is difficult to locate past age 70 or 75). Their children are in their 40s to 60s and often haven’t saved enough for their own retirement. Taxing inherited IRAs immediately tends to increase the government’s support burden.

6. Taxing inherited IRAs immediately tends to discourage investment in life annuity contracts. Proposed regulations will encourage these so-called longevity annuity contracts. Any contract with a term certain of five years or more (a contract feature that hedges against dying without receiving very many life annuity payments) would be at risk. Ten- to 20-year term certain contracts aren’t uncommon.

7. It will discourage Roth IRA conversions, which affects the federal budget in the near-term. It will also encourage recharacterizations of Roth IRA conversions for those who can recharacterize, thereby forcing the government to disgorge income taxes already paid on the Roth IRA conversion.

8. Individuals, including individuals who need the IRA for their own retirement, will experience sales pressure to empty out their IRAs and purchase life insurance to replace the “lost” value.

9. The proposal could lead to taking on more investment risk. Taking on too much investment risk places retirement security at risk. There now exist commercially available investment products designed to lower the fair market value of IRAs, and thus the income tax on taxable IRA distributions. These products will become more successful, even if they present greater investment risk that will tend to undermine retirement security. Others will take on greater investment risk in other ways (including non-traditional investments) in an effort to out-earn the “problem.”

10. It will make already over-complicated retirement account distribution rules even worse.