The Stretch IRA is an inherited individual retirement account that allows the beneficiary to “stretch” the required minimum distributions (RMDs) over a longer period based on their own life expectancy. The SECURE Act, signed into law in 2019, eliminated this loophole for non-spouse beneficiaries.
Definition and Examples of the Stretch IRA
The Stretch IRA is an inherited individual retirement account that previously allowed the new owner to extend the RMDs over time. The RMDs are determined based on the account holder’s life expectancy, and beneficiaries were able to reset the duration used to calculate the distribution. Life expectancy is determined by the IRS life expectancy table, allowing the funds in the account to continue growing without tax payments.
The SECURE Act is a comprehensive retirement law signed in December 2019 that eliminated the “Stretch IRA” option that allowed non-spouse beneficiaries to withdraw assets from inherited accounts over their lifetimes. Now, individuals who inherit an IRA must withdraw the assets within 10 years, any way and at any time they wish. Spouses and disabled beneficiaries are among the few exceptions to this rule.
How Does the Stretch IRA Work?
Eligibility: Any individual beneficiary, such as a child, grandchild, son, daughter, or even a friend, was eligible to stretch an inherited IRA. Charitable organizations and trusts were not eligible as they do not have life expectancy projections.
Required Minimum Distributions: The required minimum distribution is the amount that must be withdrawn from certain retirement plans each year. This is due to the fact that U.S. tax law stipulates that contributions made to a traditional IRA are tax-deductible. However, the tax authority wants to collect some revenue from these accounts, so withdrawals are taxed at the owner’s ordinary income rates when withdrawing funds. Due to the changes made by the SECURE Act, if the owner’s 70th birthday is July 1, 2019, or later, they do not have to withdraw funds until they reach age 77 if they are retired.
Withdrawal Requirements: An IRA owner cannot leave the account intact indefinitely, allowing it to continue growing without paying taxes; funds must be withdrawn, and within a timeframe that ultimately empties the account and exposes those funds to income tax. If account holders do not withdraw funds by the required age, the tax authority imposes hefty penalties. These requirements do not apply to Roth IRAs.
When Beneficiaries Should Start Withdrawing RMDs: Before the SECURE Act of 2019, an inheriting IRA beneficiary generally had two options. They could withdraw the entire account within five years of the owner’s death or begin withdrawing RMDs based on their own life expectancy within one year of the date of death. If their life expectancy is significantly longer than the owner’s life expectancy, this would result in lower required distributions and less income reported to the beneficiary each year, allowing the funds in the account to continue to grow without tax payments. A beneficiary who was eligible to stretch the required minimum distributions based on their own life expectancy was not required to do so. They could liquidate the inherited IRA at any time, but this would result in including all funds in the beneficiary’s taxable income for the year in which the withdrawal was made. If the beneficiary did not need the money for pressing reasons, it is usually more tax-efficient to take only the required minimum distribution each year.
Option
Surviving Spouses: The surviving spouse who is named as the primary beneficiary of the deceased’s IRA account has an additional option after liquidating the account or adhering to the 10-year window: they can transfer funds from the inherited IRA to their own IRA. This allows them to treat the inherited IRA as their own, according to their RMD requirements and life expectancy. The SECURE Act of 2019 did not affect this option.
In general, IRA beneficiaries, including surviving spouses, have several options to choose from when deciding what to do with the account. The rules regarding these options can be complex. It is wise for the beneficiary to consult a financial planning attorney, financial advisor, or accountant before making any decisions regarding the amount to withdraw from the inherited IRA.
Key Takeaways
- Extended retirement accounts allowed beneficiaries of inherited IRAs to stretch the time required to withdraw funds from the account based on their own life expectancy rather than the original account owner’s. This allows the account to continue to grow and avoids paying income taxes.
- The SECURE Act of 2019 eliminated this loophole for most beneficiaries.
- Non-spousal beneficiaries cannot extend the distribution period for more than 10 years after the original account owner’s death.
- Surviving spouses can convert the inherited IRA to their own IRA, resetting the RMD according to their own life expectancy.
Leave a Reply