SECURE Act Takes the "Stretch" out of Stretch IRA
At the beginning of the new year, legislation referred to as the SECURE Act ("Setting Every Community Up for Retirement Enhancement Act") was enacted on a nationwide basis with the goal of increasing access to retirement savings vehicles. While the primary intent is to help Americans to better prepare for retirement, a byproduct was the elimination of one of the benefits of an inherited IRA, called the “Stretch IRA.”
How the Stretch IRA has changed
Generally, contributions to traditional IRA accounts are tax deductible and distributions are taxable when withdrawn. Upon the death of the IRA account owner, spousal beneficiaries can treat an inherited IRA account as their own. However, there are special rules for non-spouse beneficiaries. The Stretch IRA was a tax savings strategy utilized by non-spouse beneficiaries of retirement accounts in order to minimize their income taxes. Prior to the passing of the SECURE Act, non-spousal beneficiaries of tax-deferred retirement accounts were required to take a taxable partial withdrawal (also referred to as a 'Required Minimum Distribution' or 'RMD') from those accounts over the course of their own lifetimes (based on the IRS’ life expectancy tables) instead of over the life expectancy of the original owner. Essentially, the Stretch IRA allowed for the deferral of taxation on IRA assets over multiple lifetimes, as long as there were assets in the account.
With the SECURE Act, non-spousal beneficiaries will now be required to remove 100% of retirement assets from the account within 10 years of the death of the original owner. Beneficiaries can take distributions in any amount, whenever they like, so long as all assets are removed within 10 years. Therefore instead of paying the income tax over their lifetime, the burden becomes compressed into a much shorter time frame, which may push beneficiaries into a higher tax bracket.
Inherited IRA opportunities still exist!
Even though the “stretch” aspect of the inherited IRA is no longer available, there are still strategies for both the account owner and beneficiary to consider when looking to reduce this tax burden. These strategies should only be considered under the guidance and advice of your tax professional and wealth advisor.
Convert pre-tax IRA assets to a Roth IRA
Account owners who wish to reduce the tax burden on their heirs could convert their pre-tax IRA assets to a Roth IRA while they’re still alive. Any assets converted to a Roth IRA will be subject to income taxes paid by the account owner, thus satisfying the government’s claim to taxes, and removing the need for an heir to pay taxes on future distributions. This strategy is best implemented if the beneficiary is expected to be in the same or higher tax bracket than the account owner.
Send RMDs to charity
Account owners must begin taking partial annual withdrawals (RMDs) from their traditional IRA once they attain age 72. However, charitably-minded account owners can reduce their potential tax burden by completing a 'Qualified Charitable Distribution' or 'QCD'. In this strategy, account owners age 70½ or older can have their RMD sent directly to their charity of choice. This not only satisfies the charitable wishes, but the distribution avoids taxation and can help to reduce the taxpayer’s Adjusted Gross Income. It’s worth noting that the maximum amount allowed per year for a QCD is $100,000.
Bequest the IRA to charity
Finally, an IRA owner wishing to engage philanthropically can choose to bequest a portion, or the entirety, of their IRA to a charity. In doing so, they can avoid the taxation on their assets that would accompany any distributions, reduce the amount of their taxable estate, and provide funding to the charitable causes of their choice. Unlike a Qualified Charitable Distribution, there is no limit on the amount that can be bequeathed.
While the SECURE Act was enacted to help individuals save for retirement, it may impact many family's financial plans, as strategies may have been implemented to take advantage of the Stretch IRA rules. As tax legislation evolves, it's important that you and your Mesirow wealth advisor along with your tax professional continually review and revisit your planning to be sure that it's appropriate for the current environment and your long-term goals.