The stretch IRA is dead and everyone (including me) is writing about how this is the apocalypse for IRA planning. Well, it isn’t. Let’s all take a deep breath. Yes, the stretch has been minimized, and this does affect some clients, particularly those with the largest individual retirement accounts, but not all clients.
Looking at the larger picture, advisers need to explain to over-worried clients that, for most, this will not be a problem. Here are five reasons why:
1. The stretch only affects the largest IRAs.
How many IRAs even make it to the beneficiary with a large enough sum to justify stretch payouts? The Treasury Department estimates only about 20% of all individuals who are required to take required minimum distributions will actually stick to the schedule and take the minimum. That means that four out of five IRA owners withdraw more than required, thereby reducing the account balance more quickly, leaving less for beneficiaries, and reducing and maybe eliminating the impact of no stretch IRA.
2. Spouses are unaffected.
Most married people leave their IRAs to their spouses, and surviving spouses are exempt from the new stretch restrictions. Spouses who inherit still have all the options they had before the SECURE Act and can continue to take RMDs as before.
For example, surviving spouses could do a spousal rollover and delay the “no stretch problem” until the next generation. They would, thereby postpone the start of the 10-year payout rule and consume more of the IRA funds during their lifetime, again, leaving less to beneficiaries and resulting in less concern about the stretch IRA.
3. Most beneficiaries don’t stretch anyway.
Windfalls don’t last long. How many beneficiaries will wait patiently for 30, 40 or 50 years to deplete their inherited IRAs? Very few. For many beneficiaries, the new 10-year rule may be a more realistic strategy. As for the smaller inherited IRAs, it might be logical to empty the account with a lump-sum distribution, especially if it is split among several beneficiaries who are in low tax brackets. Of course, if the inherited IRA is a Roth, it would pay to hold it for the full 10 years and gain all the tax-free build up.
4. The 10-year rule may provide better planning opportunities for beneficiaries.
The new 10-year payout rule is different than the old stretch IRA. Under the previous system, beneficiaries generally had to begin withdrawing in the year after death — and every year thereafter — regardless of their own tax situation. The 10-year rule provides more fertile planning territory because there are no annual RMDs during this window. This gives the beneficiary enhanced planning flexibility to take distributions when they need them and refuse distributions in the years when they don’t. Yes, the entire inherited IRA balance must be withdrawn by the end of the 10th year after death, and this could result in a sizable tax hit in that 10th year, but proper planning for the preceding decade can soften the blow.
Learn what is the 10-year stretch rule for IRAs here.
5. Most beneficiaries are in lower tax brackets.
Grandchildren are popular IRA beneficiaries. However, for the most part, under the SECURE Act, grandchildren cannot stretch inherited IRA payments over their lifetimes. They are bound by the 10-year payout rule. If a grandchild is a minor, the kiddie tax could emerge and the child might have to pay taxes on any withdrawals at the parents’ tax rate.
But 10 years is a long time. A minor grandchild will not be a minor forever. And many grandchildren are already in their 20s and 30s when they inherit. Yes, they will be forced to deplete the inherited IRA within 10 years, but younger people are typically in the lower tax brackets. While the inherited IRA payout is accelerated to 10 years, the tax hit to the younger generation will not typically be as difficult to handle. Plus, naming multiple grandchildren as beneficiaries means the original account can be spread over multiple tax returns, thereby further reducing the tax impacts.
Yes, the stretch IRA has been minimized, but there is plenty of upside remaining for advisers to work with.
For more information on Ed Slott, Ed Slott’s 2-Day IRA Workshop and Ed Slott’s Elite IRA Advisor Group, please visit www.IRAhelp.com
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