How to replicate a stretch IRA

Updated December 14, 2023 

As of 2019, the stretch IRA was eliminated with the passage of the Setting Every Community Up for Retirement Enhancement (SECURE) Act. Advisers and clients who used the stretch IRA before passage of the SECURE Act were allowed to keep the benefits.  

Now that the stretch IRA is no longer part of a client’s retirement planning repertoire, it raises the question of what other options are available. 

While the stretch IRA was a unique vehicle, tax experts say there are still other strategies advisers can use to mimic many of its features. And, in a way, offer some of its benefits. “There may be ways to recreate certain aspects of a stretch IRA, but you can never replicate the whole thing,” said Tim Steffen, director of advanced planning in Robert W. Baird & Co.’s private wealth management group. 

In this article, InvestmentNews offers ways to reproduce some features of the stretch IRA.  

Understanding the stretch IRA 

So, what was the stretch IRA? This was not an actual type of IRA per se, but more of a financial tactic applied to a Traditional IRA that was passed on to its beneficiaries. It was largely an estate planning strategy. 

One feature of the stretch IRA was that it was used as a way to limit the Required Minimum Distributions (RMDs) from an inherited IRA, thus avoiding substantial taxes. To do the “stretch”, the IRA account holder would also name children, grandchildren, or even great-grandchildren as the IRA beneficiaries instead of their spouse. Doing this would effectively stretch the lifespan of the IRA and extend its tax-deferred growth for many years, even past the life of the original owner of the account.   

The purpose of the stretch IRA 

The main point of using the stretch IRA was to create and preserve inter-generational wealth. The stretch IRA (when it was still around) allowed affluent clients to give only a portion of their sizable estate to the next generation or even the generation after them. This, while preserving most of the assets in the IRA for many years.  

How the stretch IRA worked 

In general, IRA account holders would name their spouse as the primary beneficiary with their children as contingent beneficiaries. In this setup, there was the caveat that the surviving spouse would have to take more money as RMDs than what they really needed, leaving less or perhaps nothing in the IRA for the children to inherit – including a hefty tax bill on the distributions too.  

The stretch IRA worked on the premise that your spouse and children didn’t need the extra income. And as such, you could skip a generation or two, and name grandchildren or even great-grandchildren as your beneficiaries.  

This also allowed elder family members to avoid the burdensome tax from receiving the IRA. Your grandchildren or great-grandchildren, however, still had to take Required Minimum Distributions every year. Meantime, the remaining contents of the IRA grow tax-free every year.   

Stretch IRA example 

Here’s how the stretch IRA used to work. Let’s assume that an IRA account holder has $500,000 in their account and they died on Dec. 1, 2019. What would the RMDs be like if the IRA holder could choose between their spouse, child, grandchild, or great-grandchild as their beneficiary? 

At that amount and under the IRS life expectancy rules, the distributions would have been computed by dividing the total amount by each of the beneficiary’s life expectancy. In a case like this, the RMDs for each possible beneficiary would have been as follows:  

Apart from avoiding the tax burden, the RMDs will be based on your child's or grandchild’s age. And since they will be significantly younger, their RMDs would be much less than what your spouse and children would have to receive.   

Exceptions for the Stretch IRA 

Qualified beneficiaries 

Even though the stretch IRA has been eliminated, there are still strict exceptions in place.  

The following named, qualified beneficiaries who may still benefit from a stretch IRA under the old rules include:  

• a minor child 
• beneficiary who is disabled 
• beneficiary suffering from a chronic illness 
• beneficiary who is at most 10 years younger than the account holder 

Account holder’s spouse 

Spouses who inherited either a Traditional or a Roth IRA can still use the stretch IRA. Should the original account holder name their spouse as the beneficiary and they wish to “stretch” the IRA, then they must begin to take RMDs, either:  

• by the end of the year of the account holder’s death 
• by the year the account holder would have reached 73 

Meanwhile, a minor child beneficiary of the original owner can also stretch out the IRA until they reach the age of majority, and then the same 10-year rule kicks in. These new requirements apply to IRAs inherited after Dec. 31, 2019.  

As for the other non-qualified, non-spousal heirs, the SECURE Act removed this option for them. They are obliged to empty the account within 10 years. 

Speaking of the 10-year rule, some clients might think they can simply let the money in your inherited IRA grow from years 1 through 9, then withdraw it all in year 10. That’s not how the rule works! Here’s a video for clarification:  

IRA owners who pass on before the changes take effect 

Those who passed away before the SECURE Act’s changes were implemented on Dec. 31, 2019 may still apply the stretch IRA on their estate holdings.  

Strategies for inheriting an IRA post-SECURE act  

Clearly, the now-defunct stretch IRA offered some great tax savings and benefits. Stricter rules on IRA withdrawals of non-spousal beneficiaries affected millions of households, not just the wealthy ones. So, after the SECURE Act removed it, here are the available alternatives to the stretch IRA:  

1.  Do a Roth conversion 

Anyone who is still working making contributions to their Traditional IRA may consider converting it to a Roth IRA. This strategy would reduce or do away with a significant tax bill for their future beneficiaries. If they leave their employer, they can also rollover an old 401(k) to a Roth IRA.  

With a Roth conversion, beneficiaries other than the spouse can withdraw from an inherited Roth without paying taxes since the contributions consist of after-tax money. These may be either direct Roth IRA contributions, rollovers, or qualified converted contributions.  

Beneficiaries may also withdraw earnings from a Roth tax-free if the account was at least five years old when the original account owner passed away. The original account owner must have paid income taxes on the Roth conversion, whether partial or total.  

According to Leon LaBrecque, chief growth officer of Sequoia Financial Group, “Instead of trying to leave them money when you die, you can use a Roth as part of their inheritance.”  

2. Take out an insurance policy 

Another option for retired couples who don’t need the RMDs from their IRA can also potentially boost their IRA. They can use a portion of their RMDs to buy a life insurance policy. The rest of the money can be left to grow in the account. 

If the retired couple assigns ownership of the life insurance policy to their children, another beneficiary, or an irrevocable trust, the policy’s death benefit is outside of their taxable estate holdings, so the proceeds and estate are both free from income and estate taxes.  

Insurance premiums paid to beneficiaries may be considered as gifts, and subject to gift tax. The amounts should be less than the federal annual gift tax exclusion amount of $17,000 per person in 2023.  

Married couples may combine their annual gift tax exclusion for a limit of $34,000 a year to avoid the tax. Filing a gift tax return is required for such an arrangement.  

3. Set up an irrevocable trust 

Those with large taxable estates and robust IRA accounts can also replicate the regular, flexible payouts of stretch IRAs by funding an irrevocable trust with a life insurance policy. In this strategy, the IRA account holder creates a trust for their family and purchases a life insurance policy within the trust. 

The account owner then takes distributions from the IRA and “gifts” the trust intended as annual premium payments on the policy years before their death. When they pass on, the death benefit funds a trust set up to provide regular income to the beneficiaries.  

Read more: Why set up an irrevocable trust? 

4. Establish a charitable remainder trust 

An IRA account owner can fund a charitable remainder trust with a beneficiary other than their spouse. This strategy can support their loved ones and help them save on taxes while benefiting their favorite charity, with just a portion of their IRA.  

In this setup, the asset owner can create and fund this trust with IRA assets when they pass on. Their beneficiaries would then receive a regular income from the trust, as with RMDs from an inherited IRA. The IRA owner can choose to distribute the assets over a certain period or during the beneficiary’s lifetime, and the assets are only taxed when they leave the trust.  

The tax deduction is claimed by the estate of the original IRA owner once they create the trust. The longer the period for the payments, the lesser the tax. It’s important that the term, the IRA owner’s and the family’s estate planning goals should be discussed prior to establishing this trust.  

When the beneficiary dies or the term of the trust expires, the assets remaining in the trust go to a named charity, tax-free. 

Estate planning without stretch IRA 

Estate planning was easier to do with the stretch IRA around. But after the SECURE Act removed it, some financial advisers and their clients likely felt as if the rug was pulled from under them.  

Instead of lamenting the loss of the advantages offered by the stretch IRA, there are still viable strategies to get the best outcomes for real estate planning. As with most financial issues, it's a matter of doing diligent planning and number-crunching.  

What do you think of these strategies to replace stretch IRA? Do you think they’re effective? Let us know in the comments.