Protecting Your Wealth - Estate Planning Strategies to Consider Following the Elimination of the Stretch IRABy Michele A. Lazzara | March 16, 2021
On December 20, 2019, the Secure Act was signed into law, introducing a number of changes to the existing retirement plan contribution and distribution rules. One of the most notable was the elimination of the “stretch IRA,” an often-employed strategy that helped to limit required distributions on an inherited IRA and, in many cases, avoid a sizable tax bill in the process. The concept was simple - instead of naming their spouse as the beneficiary of the IRA, an account holder would name children, grandchildren or even great-grandchildren. The distribution would then be at a rate based on the beneficiary’s life expectancy and not that of the original account owner. This “stretched” the lifespan of the IRA, and equally as important, it allowed the funds remaining to grow on a tax-advantaged basis. For this reason, the stretch IRA was a very popular strategy used in estate planning.
Under the Secure Act, an inherited IRA must now be fully distributed to its beneficiary within ten years, except if the beneficiary is a surviving spouse, an eligible minor, a person less than ten years younger than the original owner or the disabled or chronically ill. There are no specific requirements for how an account is distributed during that ten-year period, which provides some flexibility for the new account owner to time the distributions in a way that gives them the most benefit. For example: the beneficiary can take a lump sum at the beginning or end of the ten years, withdraw a set amount every year or vary their annual distributions depending on their own income. Note that the new ten-year rule applies only when the original owner passes away after December 31, 2019. Beneficiaries who inherited IRAs prior to that date are grandfathered and can still follow the old rules, which allow the stretch IRA.
The Secure Act did not change the rules that apply when an IRA does not have a beneficiary designation. If this situation occurs, the required distribution depends on whether the IRA owner passes before or after reaching his or her required beginning date to take required minimum distributions. If the owner turns 70 ½ in 2020 or later, the required beginning date is age 72 (another provision of the Secure Act). For all others, it is age 70 ½. If the IRA owner dies before the required beginning date, the entire IRA must be distributed within five years. If the owner is already taking distributions, the IRA can be distributed as if the owner still lived, using the owner’s remaining life expectancy based on IRS tables.
With the changes introduced in the Secure Act, estate planning has become more challenging. In light of the new law, it is wise to revisit estate plans and IRA beneficiary designations and consider alternative strategies, if necessary. With the loss of the stretch IRA, account holders may need to determine a new course of action. A non-spouse IRA beneficiary is still an option but can be a costly one if the non-spouse is in or near their peak earning years. IRA holders will want to carefully consider who they name as beneficiary and understand the distribution options.
If the elimination of the stretch IRA has impacted your estate plans, consult with your advisor to see if any of the following can help guide a new approach.
Consider alternative investment vehicles. Taking withdrawals from an IRA to purchase life insurance is one possibility. The death benefit to beneficiaries would be tax-free. Another option that should always be considered, especially when tax rates are low, is to convert to Roth IRA. One of many tax benefits of a Roth IRA is that non-spouse beneficiaries may be able to withdraw contributions from an inherited Roth IRA tax-free.
Try to spend down your IRA. A lower balance in your traditional IRA will not be hit with taxes so quickly. If you know you will be gifting funds in the near future, gifting from your IRA can help to reduce the balance. Charitable gifting in the form of a qualified charitable distribution from your IRA can also serve to lower the balance while supporting philanthropic endeavors.
Be strategic with IRA trusts. There are a number of tax planning opportunities related to IRA trusts. Remember that the state associated with your IRA trust can play a big role in determining the tax implications, so choose low-tax states for IRA trusts whenever possible to help avoid substantial state income or inheritance taxes. Options such as a multi-generational spray trust can spread the tax burden across multiple generations, including children, grandchildren and great-grandchildren. In light of the many changes affecting estate planning today, redraft IRA trusts as necessary to maximize tax-planning opportunities.
The considerations above represent just some of the ways an individual can combat the loss of the stretch IRA as an option. Consulting with a trusted advisor is always recommended to determine the best course of action, and with a number of ongoing developments affecting estate planning today, is highly encouraged. Your advisor can help determine which strategies will provide the most benefit to you and your loved ones as you look to protect and manage your wealth.
About Michele A. Lazzara
Michele A. Lazzara, CPA, CGMA, is a Partner at Marks Paneth LLP. She has more than 20 years of public accounting experience and provides practical, comprehensive planning, consulting and advisory services to clients in a variety of industries. Her broad background includes experience with corporate/partnership tax planning, financial planning and individual tax planning as well as matrimonial and divorce planning. She has a proven track record serving closely held businesses, nonprofit organizations, professional services firms... READ MORE +