Death of the Stretch IRA

One of the biggest changes in the area of estate planning just occurred, the death of the stretch IRA and minimum required distribution rules (MRD) for most beneficiaries.  A stretch IRA is not an actual IRA, it’s a concept concerning an IRA (or 401(k), 403(b), 457, or other similar qualified account).

When the owner of an IRA dies, he can name a beneficiary on his IRA account who will take ownership of the IRA. Before the recent change, after the death of the account-owner, the beneficiary-owner had to take money out of the IRA each year based on the beneficiary’s life expectancy.  The younger the beneficiary, the longer the beneficiary had to take the money out of the IRA under the MRD rules.  For instance, if a beneficiary were twenty years old, she may have fifty years to remove the money out of the account.  If the beneficiary were sixty years old, she may have twenty years to remove the money from the IRA.

The longer the money remains in the IRA the better because the money in the IRA grows on a tax-deferred basis. The beneficiary-owner does not have to pay taxes on the money until the money is removed from the IRA.

A stretch IRA is an IRA on which the owner has named a beneficiary who is substantially younger than the original account owner. When the account-owner dies, the age of the beneficiary-owner determines how quickly the IRA must be distributed to the beneficiary-owner under the MRD rules and the longer the money can grow tax-deferred.  This was a substantial tax benefit, though statistic show that only 20% of beneficiary-owners left the money in the IRA for as long as they could have under the MRD rules.  This makes sense to me because most people don’t want to wait fifty or even twenty years to use their money, even if there is a tax benefit associated with not spending it.

With a law change that occurred at the end of 2019, for most beneficiaries, the MRD rules are dead and, with their death, stretch IRAs. Under the new law, a beneficiary-owner does not have to take an MRD, but she must remove all of the money from the IRA within ten years of the account-owner’s death.  It may benefit the beneficiary-owner to remove a portion of the money each year and spread the tax liability out over multiple years, but she does not have to remove the money until the end of the 10th year.

Since only 20% of beneficiary-owners currently take full advantage of the stretch IRA concept, this may not be too consequential for current beneficiary-owners, but as the value of IRAs increase for account-owners (and I have noticed more of my clients owning more and more of their wealth in IRAs), the inability to stretch the IRA may have greater income tax consequences for beneficiary-owners. This makes sense because the last of the old-timey (defined benefit) pension plan owners is dying now.  The first wave of individuals who are wholly reliant on IRAs for retirement are coming into retirement age.  These individuals have larger IRAs than previous retirees and the value of newly-minted retirees and aging retirees will grow.

Assuredly, the federal government realized this and realized that a substantial portion of the nation’s wealth was being tax-deferred. That is probably why the government changed the law on stretch IRA, effectively preventing future generations from deferring taxes for decades on money their parents leave them.

Many estate plans were drafted in a way to take maximum advantage of the stretch IRA and minimum distribution rule concepts. These estate plans may have to be revised.  A typical estate plan would contain a testamentary trust with a “conduit trust” feature, meaning that the terms of the trust required the minimum distribution amount to be distributed to the trust beneficiary each year.  Now, with the elimination of minimum distribution rules, this term should be modified as there are no minimum required amounts.

The client may want to draft their plan with an accumulation trust that enables IRA proceeds to be accumulated in the trust and put in place a trust protector, an individual who could modify the terms of the trust if needed to maximize tax benefits in the future. This sort of plan would allow for long-term goals to be met without the need to modify the estate plan in the future.

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