The stretch IRA era is over.
The SECURE Act was signed into law in 2020, meaning that retirement account owners would have to look for other options to leave funds to their beneficiaries.
In this article, we will define what a stretch IRA was and the legislation that killed it. We will also look at options for retirement account owners and the different rules that came into effect.
Here is everything you need to know about the stretch IRA era and beyond.
No. In the wake of new legislation, the stretch IRA is no longer available. But before we look at the specific legislation, and the options still available for retirement account owners, let’s define the stretch IRA (Individual retirement account).
Before the SECURE Act of 2020, an individual designated beneficiary could extend post-death “stretch IRA” required minimum distributions over their lifetime. A young grandchild might have a 70-year payout period. This is no longer the case.
The clients most affected are those with the largest IRAs who had planned on leaving the lion’s share of those accounts to extend over the lives of their children and grandchildren. This especially includes any clients who named a trust as their IRA beneficiary.
Under a stretch IRA, the beneficiary could extend the annual required minimum distributions (RMDs) needed over their own lifetime, not the lifetime of the original account owner.
The SECURE Act stands for the Setting Every Community Up for Retirement Enhancement Act. The SECURE Act was signed into law by then-President Donald Trump on December 20, 2019.
At the time, the SECURE Act brought about the biggest changes in retirement policy in a decade. It provided legal protections for employers that included the following:
The SECURE Act also allowed long-term part-time workers to participate in 401(k) plans and require plans to make lifetime income disclosures.
The bill required most non-spouse beneficiaries of individual retirement accounts to take distributions over 10 years instead of over their lifetimes. The change would increase tax revenue to pay for other parts of the bill.
One alternative to Stretch IRAs is Roth conversions. Pre-retirees who want to continue contributing to their retirement accounts should convert their traditional IRAs into a Roth. Doing so would eliminate or reduce a significant tax bill for their heirs. They might also be able to rollover an old 403(b) or 401(k) to a Roth if they have left that employer.
Since the funds were contributed using after-tax dollars, non-spouse beneficiaries can withdraw contributions from an inherited Roth tax-free. Those contributions are either qualified converted and rollover contributions or direct Roth IRA contributions.
No. Inherited Roth IRAs are subject to the same 10-year payout rule, except that the distributions will generally be tax-free. Advisers will want to look at doing more Roth conversions to eliminate what could be a big tax bill within 10 years after death.
The five-year rule for stretch IRAs referred to the amount of time that must pass before the client could take distributions from the IRA. To withdraw funds from a stretch IRA, the account must have been opened for at least five years at the time of death of the original account holder.
Here’s an in-depth look into the five-year rule for Roth conversions.
Yes. Original beneficiaries who inherited IRAs from account owners who died before 2020 can still use stretch IRAs. These are essentially grandfathered in. But after the original beneficiary dies, the new 10-year payout schedule will apply to successor beneficiaries.
Here is an example:
An IRA owner died in 2019 and left his IRA to his grandchild. The grandchild’s stretch period is 60 years. That schedule is grandfathered and remains the same. When the grandchild dies, though, any funds remaining in the inherited IRA that go to the grandchild’s beneficiary (the successor beneficiary) will have to be paid out within 10 years. The successor beneficiary is not grandfathered.
Under the legislation, however, there are five categories of beneficiaries exempt from the 10-year payout schedule. The law carves out exemptions for certain beneficiaries now called eligible designated beneficiaries or EDBs. They are:
The old stretch rules still apply to these beneficiaries, the same as before, but only while the beneficiaries still qualify as EDBs.
Here is another example:
An IRA owner dies in 2020 and leaves his IRA to his minor child. The minor child can still stretch the same as before, but only until that child reaches the age of majority (which is age 18 for most states). Once the child reaches majority, he is no longer an EDB, and then is subject to the new 10-year rule.
No. The law is clear on this. The EDB exemption from the 10-year rule is only for the child of the IRA owner or plan participant.
Example:
An IRA owner dies in 2020 and leaves her IRA to her grandchild. The grandchild, no matter what age, will be subject to the 10-year payout after death, unless that grandchild qualifies as disabled or chronically ill.
It’s likely that a trust was named for that grandchild. That trust is also subject to the 10-year rule. That’s probably not what the client wanted. The reason she named a trust was to protect those funds for the grandchild. Certain trusts may still do this, but they would all still be limited to a 10-year payout.
No. A stretch IRA cannot be rolled over. The choices for distributing the value of the account depend on whether the client is considered an EDB.
Distribution rules also differ depending on the date of the account owner’s death. It also depends on whether the original account owner died before or after their required start date for RMDs.
Stretch IRAs initially allowed non-spouse beneficiaries to take RMDs based on that person's own life expectancy. However, since the SECURE Act was enacted in 2020, stretch IRAs have been disallowed in most cases. Exceptions to this are beneficiaries within 10 years of the original account holder's age. Additional exceptions include beneficiaries who are minors, chronically ill, or disabled.
Non-spouses who inherited IRA assets prior to December 31, 2019 are grandfathered in. These beneficiaries can follow the old rule. That only requires them to withdraw an RMD based on their own life expectancy, rather than the life expectancy of the original account holder.
Under the 10-year rule, there are no RMDs during the 10 years. Instead, the entire IRA balance must be emptied by the end of the 10 years. Beneficiaries can withdraw any amounts they wish over the 10 years. That means beneficiaries do have some planning flexibility during the 10 years to withdraw funds when it best fits their tax situation.
There are, however, exceptions for certain eligible designated beneficiaries. These are defined by the IRS and include:
Note: after a minor child reaches the age of majority, then they would become subject to the 10-year rule.
As we have seen, the stretch IRA era is over. Legislation signed into law in 2020 by then-president Donald Trump meant that retirement account owners would have look for other options. For anyone who had stretch IRAs before that period, they can be grandfathered in. It is also important to understand the 10-year stretch rules for IRAs.
Visit our Awards & Recognition section where we feature the top-performing financial advisers across the USA. Contact them to share insights on stretch IRA alternatives and other retirement planning strategies.
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