Signed into law almost a year ago, the SECURE Act bestowed IRA owners with some new perks—they can take more time to build up tax-deferred savings and growth, for instance, before they have to start making distributions from their retirement accounts. On the flip side, however, the act also spelled the end of the stretch IRA. Fortunately, your clients have options when it comes to mitigating the negative effects of this change on their financial plans.
Before the SECURE Act, individual beneficiaries could “stretch” the withdrawal of their inherited retirement accounts based on their life expectancy. What’s changed? Now, most beneficiaries will have to deplete the inherited retirement account within 10 years of the original owner’s death. Some exceptions to this rule include:
A beneficiary who inherited an IRA from someone who died before January 1, 2020
The surviving spouse of the IRA owner
A child of the IRA owner who has not reached the age of majority (the account will need to be depleted within 10 years of the child reaching the age of majority)
A disabled or chronically ill individual
An individual who is not more than 10 years younger than the IRA owner
In most cases, the elimination of the stretch IRA will result in substantially less tax-deferred growth, as well as more taxes due on withdrawal.
7 Strategies for Addressing the End of the Stretch IRA
To help mitigate the potential negative ramifications of changes to IRAs, you may want to suggest these strategies to your clients.
1) Convert to a Roth IRA. Although inherited Roth IRAs are subject to the new rule, distributions remain tax free. With tax rates at historic lows, it could be a good year to accelerate Roth conversions so that beneficiaries (who may be in a higher tax bracket) can avoid being heavily taxed on distributions.
2) Disclaim the IRA. Beneficiaries can “disclaim” or refuse inherited assets without tax implications. To do it, they must submit a qualified disclaimer in writing within nine months of the IRA owner’s death. Also, the beneficiary must not have received or exercised control over the property, and the disclaimed property must pass to someone other than the disclaimant.
This may be a plus for a surviving spouse who does not need those retirement funds. By taking the right to disclaim a portion of the inherited IRA, the ultimate beneficiaries (e.g., the children) would avoid a larger share of assets being distributed over a single 10-year period. In this instance, one 10-year period starts when the first spouse dies. Another period would commence for the remaining balance of the account upon the death of the second spouse.
3) Name a trust as beneficiary. Without the lifetime stretch option, there is less tax incentive naming an individual as beneficiary as opposed to a trust where the trustee could have discretion as to when distributions are made. Clients who named a trust as an IRA beneficiary before the implementation of the SECURE Act, however, should review the current estate plan with an attorney. Some trusts drafted before the SECURE Act passed may now be obsolete, resulting in a distribution pattern that works against the trust’s original intent.
4) Name a charitable remainder trust (CRT) as beneficiary. These trusts are structured so that the IRA beneficiary collects a stream of income from the assets over a specified period. Once that period ends, the charity collects whatever is left. The CRT isn’t taxed on distributions or earned income from the IRA. The beneficiary, however, is responsible for any taxes owed on distributions from the CRT. Therefore, the CRT is, in effect, simulating the benefits of the former “stretch” IRA. But be aware that, only in a few circumstances, an individual beneficiary could receive more from a CRT than withdrawing from an IRA over a 10-year period. So, it is typically necessary that the IRA owner be at least somewhat charitably inclined when selecting a CRT as beneficiary of an IRA.
5) Pay premiums on life insurance. Depending on insurability, you could explore the client taking a withdrawal from the retirement account to pay premiums on a life insurance policy. In this scenario, your clients may find that the tax-free payout from the policy is a better option than leaving the retirement account to the beneficiary.
6) Make a qualified charitable distribution (QCD). Individuals older than 70½ are entitled to make a QCD. This is a tax-free gift from an IRA of up to $100,000 per year that’s payable directly to a charity. Because IRAs will be a less attractive inherited asset, QCDs may become more in favor, and so could the motivation for tax-free depletion of retirement accounts.
7) Revise the estate plan. The estate plan could take a more comprehensive, asset-by-asset approach, rather than continuing to split up assets by percentage. For example, the account owner might earmark IRA assets to be distributed to minors or individuals in lower tax brackets and designate a larger proportion of non-retirement assets to those with higher incomes.
Focusing on Future Goals
The changes adopted as part of the SECURE Act are wide ranging and complex. Although many of the changes benefit those saving for retirement, the elimination of the stretch IRA could have negative consequences for your clients. It’s important to review all aspects of their financial plans and beneficiary elections to understand how they may be affected by the SECURE Act and look for alternative options that can help them better prepare for the future.
Commonwealth Financial Network® does not provide legal or tax advice. You should consult a legal or tax professional regarding your individual situation.