What was a stretch IRA? Prior to January 1, 2020 rules allowed an IRA account holder to name a spouse as primary beneficiary and children as the contingent beneficiary. After the account owner’s death, the spouse and then the children could take distributions over their respective life expectancies. This was commonly known as the Stretch IRA.
Congress has felt for a long time that inherited IRAs should not be used for retirement. On January 1, 2020, the Secure Act changes many of the rules that used to apply.
- Required beginning date: The required beginning date will change from age 70 ½ to age 72. However, if you were 70 ½ on December 31, 2019 your required beginning date will not change.
- Required distribution period: a new 10-year distribution period applies to almost everybody who inherits an IRA after January 1. In addition, grandchildren are subject to the same 10-year distribution period, so you can no longer get a longer stretch by naming grandchildren.
How the new rules work: Starting January 1, 2020 the spouse of an account owner can still roll over the IRA and take distributions over his/her life expectancy, but the children are now limited to 10 years from the date of the account owners death. This means that the children will face a significantly higher income tax bill on the IRA distributions unless the account owners review and alter their plans. Depending on the size of the IRA, the children could face several hundred thousand dollars in additional income taxes.
There are several possible solutions to reduce the tax and to simulate the stretch, but none will achieve quite the same effect. We will discuss several possibilities. Your children can always adjust the distributions to fit their own tax situation.
First, giving some or all of your IRA at your death (or spouse’s death) to charity you wish to support is still a good solution. If you leave the IRA to your children, they will pay income tax as they withdraw it. After January 1, they will pay more income tax because the distribution period is shorter. If you leave it to charity nobody pays income tax on the portion going to charity.
Second, the Qualified Charitable Rollover is still effective if you want to leave your required minimum distribution to charity. This still applies to those more than 70 ½.
Third, consider a Roth IRA conversion to reduce future taxes for your beneficiaries. A Roth IRA conversion is an income tax election where you as the IRA account owner elect to pay income tax on some or all of the IRA now so that you don’t have to take distributions and your children can take out the Roth IRA over the 10 year period tax free. You should only consider it if you have enough time to make up the amount lost to income taxes and your children or other beneficiaries face a lower bracket.
Life insurance can be a good option if you are insurable.
Finally, you could create a testamentary charitable remainder unitrust. This is a more complicated option which would allow you to simulate the stretch for the lives of the income beneficiaries and provide for your favorite charitable organizations.
Testamentary means it is set up at the donor’s death. A charitable remainder unitrust is an irrevocable trust which provides for a payment to one or more income beneficiaries of an amount between 5% and 50% of the value of the assets as determined on a specific date each year. If the value of the trust assets increases, the distribution will increase and if the value decreases the distribution will decrease. On the death of the income beneficiaries the amount remaining goes to charity.
The payout can be for the life or lives of the income beneficiaries or for a period of years not longer than 20. At the end of the distribution period for the income beneficiaries the balance goes to charity. The amount of the distribution will depend on the value of the assets. Distributions will be subject to income tax. Depending on the assets contributed, some could be tax free, capital gains, ordinary income or a return of capital.
We will be reviewing our client’s estate plans and calling you to discuss what if anything you want to do. If you have questions or want to make other changes, please call the office for an appointment. You will need to move forward to reduce income taxes for your family.