I wrote recently about some of the major changes to retirement planning with the passage of the SECURE Act. Now that it is fully in place and I’ve had a bit more time to absorb it, I wanted to touch base on what I consider to be one of the worst changes with this act – the death of the Stretch IRA.
As a refresher, the Stretch IRA is a wonderful planning concept to pass along assets within an IRA. When someone inherits an IRA they have the ability to “stretch” their required distributions over their lifetime, which could be significantly longer than the original IRA’s owner’s lifetime. For example, if you pass your IRA to your grandchild, they may have been able to stretch their IRA distributions over 50, 60 or 70 years. Unfortunately, there is a big change with the SECURE Act that impacts the ability to effectively execute the Stretch IRA.
That change is most non-spousal beneficiaries who inherit an IRA must now take out distributions within 10 years. This is a significant change and one that may catch many who have been planning on a Stretch IRA. Now, this new 10-year rule does not apply to spouses, disabled children, beneficiaries within 10 years of age of the original IRA owner (such as a sibling), minor children up to age of majority, and chronically ill individuals. And, if you are already taking money out of a Stretch IRA you are grandfathered in.
The big drawback is a common denominator – taxes. This elimination of the Stretch IRA is a tax grab by the government. I guess they decided they didn’t want to wait decades for their taxes anymore. I get it, who wants to wait. Unfortunately, it has thrown a huge wrench into the estate plans of many people. Let me share one example.
Imagine you are married, have say $2 million in tax-deferred IRA accounts, and have one child who is an adult with a good job. By bad luck you and your spouse pass away at the same time. Your child, who happens to be a GenXer now inherits $2 million in IRA money they must take out over the next 10 years. As I mentioned, this child has a good job and their income is in the 22% tax bracket. Well, by having to take money out over 10 years versus their real life expectancy of closer to 40 years there is a massive change in their tax projections. A few years after they inherit this money their required distributions will most likely push their tax bill up by nearly 50% to the 32% bracket.
Yeah, having to pay too much in taxes in a real drag (please note sarcasm font), but you know I am not an advocate for having to tip the IRS if you don’t need to. Unfortunately, these changes in the Stretch IRA have now removed a simple way to keep taxes under control and let your savings benefit your loved ones. There are still other planning options out there. They include buying insurance, doing some more complex legal work, and Roth conversions. Yes, the Roth IRA still has to be distributed in 10 years, however the distributions are without taxes!
Again, if you’ve been paying attention to my writings you know I am a big proponent of Roth conversions. This is part of the reason I hate when advisors push clients to roll old 401k balances into IRAs because it messes up Backdoor Roths and conversions, but I digress. My point is – expect to hear more from me about Roth conversions, especially as we are still in a relatively friendly tax environment for individuals. Remember, the tax changes under TCJA for corporations is permanent, but it is only temporary for individuals and your window is starting to close to do these conversions. I will probably also talk about some insurance and estate planning strategies to help deal with the loss of the Stretch IRA. So, stay tuned to my future articles.