- A stretch IRA was an estate planning method that allowed a non-spouse beneficiary to continue to benefit from the tax-deferred benefits of an IRA.
- The recipient was required to take IRA distributions, but at a rate determined by the beneficiary’s life expectancy rather than the account owner’s.
- The SECURE Act of 2019, which requires that inherited IRAs be emptied within 10 years of the original account holder’s death, regardless of the beneficiary’s age, put an end to the practice.
Who can still do a stretch IRA?
Beneficiaries who inherited an IRA before 2020 are grandfathered, meaning they can continue to “extend” post-death distributions for as long as they live. The new 10-year payout rule has little impact on sole-spouse beneficiaries.
How long can you stretch an IRA?
The Roth IRA semi-stretch plan Roth IRAs bequeathed to non-spouse beneficiaries can enjoy federally tax-free income and profits for as long as the account owner lives and for at least 10 years after that, even after the SECURE Act. That has a good chance of working out.
Will Stretch IRA be grandfathered?
Before 2020, anyone who became an IRA beneficiary before that date was normally entitled to take RMDs from the inherited IRA based on their life expectancy. Anyone in such situation can keep taking their RMDs as they were before the SECURE Act was passed. Of course, a pre-2020 IRA recipient can take a distribution that is greater than the RMD at any time.
No one has been named as a beneficiary. It’s critical that an IRA’s beneficiaries be one or more individuals, and only individuals. An IRA must have a chosen beneficiary to maximize tax deferral, and only persons can be designated beneficiaries, according to the regulations.
When no beneficiary is named or when the estate or trust (with some exclusions) is identified, an IRA does not have a designated beneficiary. A chosen beneficiary is not a charity, business, or other legal organization.
The restrictions that apply when an IRA doesn’t have a specified beneficiary were not changed by the SECURE Act.
The necessary distribution schedule for these IRAs is determined by whether the IRA owner died before or after the mandatory beginning date for RMDs. The required starting date for people who turned 701/2 in 2020 or later is age 72. Age 701/2 is the required start date for everyone else.
The five-year rule applies if the IRA owner died before the statutory start date. Within five years, the full IRA must be distributed. When an IRA owner dies after the statutory start date, the IRA can be distributed as if the owner were still alive, using the IRS’s life expectancy tables to determine the owner’s remaining single life expectancy. Obviously, the IRA can be distributed more quickly than is required.
Beneficiary is the surviving spouse. The 10-year rule does not apply to surviving spouses who are IRA beneficiaries. Survivors’ options are the same as they were prior to the SECURE Act.
A surviving spouse’s option is to roll the IRA over to an IRA in the surviving spouse’s name. A new IRA or an existing IRA can be used. This is referred to as a “new start” IRA because the surviving spouse can treat the IRA as if it had always been his or hers, with no reference to the deceased spouse’s IRA.
In a fresh start IRA, the surviving spouse pays RMDs based on his or her age and specifies beneficiaries for the IRA without referring to the IRA of the deceased spouse.
The surviving spouse can also treat the IRA as though it were an ordinary inherited IRA. The distinction is that the surviving spouse is no longer bound by the 10-year requirement after the SECURE Act. The surviving spouse of an inherited IRA follows the old regulations, which allow for a Stretch IRA with RMDs taken over the life expectancy of the surviving spouse.
Beneficiaries who are eligible. The eligible designated beneficiary is a new type of beneficiary created under the SECURE Act (EDB). A beneficiary who is exempt from the 10-year rule is known as an EDB. An EDB is a surviving spouse.
A beneficiary who is not more than 10 years younger than the deceased IRA owner, a minor child of the deceased IRA owner, a crippled or chronically ill beneficiary, and a beneficiary who is not more than 10 years younger than the deceased IRA owner are all EDBs.
A grandchild is not an EDB, although a minor child is. Furthermore, a minor child is only an EDB while he or she is under the age of majority in their state (18 in most states). The 10-year clock starts ticking once the beneficiary achieves the age of majority.
After 2019, IRA estate planning took on a whole new meaning. You want to make certain that you name the correct beneficiaries and that they receive sound counsel. You could also want to think about using one of the ways that effectively allows you to dodge the new rules while still getting similar, if not better, outcomes than the previous Stretch IRA.
What is the IRA 10-year rule?
The following are the most relevant aspects of the “10-year” rule as it relates to the SECURE Act and inherited IRAs:
(1) Non-EDBs have ten years to complete their inherited IRA withdrawals; and
(2) During the 10-year period, non-EDBs are not subject to required minimum distributions (RMDs). In other words, they are not obligated to withdraw a certain amount each year during the course of the 10-year period. They can wait until the 10-year time is up and then withdraw the full inherited IRA account in one big sum.
In March 2021, the IRS released Publication 590-B for 2020, which included a section outlining the 10-year inherited IRA withdrawal rule. The IRS intimated in their explanation that RMDs would be required during the 10-year term, which was not the case.
Publication 590-B was recently updated by the IRS to clarify and rectify its position on the 10-year rule. The IRS specifically indicates that no RMDs are due if a non-inherited EDB’s IRA is fully withdrawn by the end of the 10-year anniversary of the original IRA owner’s death.
Harold, who owned a regular IRA, passed away on July 15, 2020. Vivian, Harold’s adult daughter, had been nominated as the sole beneficiary of his typical IRA. Vivian has until December 31, 2030, to withdraw her inherited IRA funds. Vivian has the option but not the obligation to withdraw any amount she wants before December 31, 2030.
The IRS further noted that, while EDBs are still eligible for lifetime distributions from their inherited IRAs based on their life expectancy (thus the term “stretch IRA”), they can choose to use the 10-year rule instead. This is only the case if the IRA owner passed away before the required start date. Individuals born before July 1, 1949, must begin on April 1 of the year in which they turn 70.5; those born after June 30, 1949, must begin on April 1 of the year in which they turn 72.
In some cases, an EDB may prefer the flexibility of the 10-year rule to being bound into a rigorous “stretch IRA” RMD plan each year, even if the time extends beyond the 10-year period.
Can a trust stretch an IRA?
Until recently, if you nominated someone other than your spouse as the beneficiary of your IRA or qualified retirement plan, that individual could take distributions over the course of his or her life. This method, known as a “stretch” IRA, provided significant benefits by allowing payouts to be spread out over several decades. However, the SECURE Act of 2019 severely curtailed these benefits (with few exclusions) by requiring beneficiaries to complete distributions within ten years.
Fortunately, you may still replicate some of the benefits of a stretch IRA with the right tactics. If you have a charitable bent, naming a charitable remainder trust (CRT) as the beneficiary of your IRA or qualified plan is one option.
Spreading distributions
Stretching distributions across a beneficiary’s lifetime has two major advantages:
- It permits the money to grow and compound tax-deferred for as long as feasible; and it allows the funds to grow and compound tax-deferred for as long as possible.
Stretching distributions means that a large amount of the money will be distributed during retirement, when the beneficiary’s tax rate is likely to be lower. If payouts are spread out over ten years, they may be received during a beneficiary’s peak earning years and subject to higher tax rates.
Beneficiaries must take distributions within 10 years under the SECURE Act, with a few exceptions. As before, couples have the option of taking distributions over the course of their lives or rolling the funds into their own IRAs and deferring withdrawals until they reach the age of 72. Individuals who are disabled or chronically ill, or trusts established for their benefit, are likewise exempt. Minor children may stretch distributions over their lifetimes until they achieve majority age. The balance must be distributed within ten years after they are adults.
Using a CRT
If your intended beneficiary does not fall under one of the exceptions, naming a CRT as beneficiary of your IRA or qualified plan can give some of the benefits of a stretch IRA if correctly arranged. A CRT is an irrevocable trust that distributes a portion of its assets to one or more individual beneficiaries for the rest of their lives or for a period of up to 20 years. The leftover assets are then donated to charity.
Annual distributions may be based on a fixed proportion of the trust’s starting value, and the percentage distributed might range from 5% to 50%. (a charitable remainder annuity trust, or CRAT). It could also be based on a yearly recalculation of a fixed proportion of the trust’s value (a charitable remainder unitrust, or CRUT). CRUTs are often preferred because annual recalculations ensure that rewards keep pace with inflation and that the funds are never depleted.
IRS guidelines
The monies are not taxed until they are delivered to your noncharitable beneficiaries because a CRT is a tax-exempt business. When properly structured, a CRT can provide benefits similar to a stretch IRA if dividends are stretched out over a 20-year term or a beneficiary’s lifetime.
The actuarial value of a charitable beneficiary’s remaining interest must, however, be at least 10% of the trust’s starting value, according to IRS requirements. The necessity to maintain a minimum value for charity may limit the duration of the trust or the size of disbursements. This obligation may even make establishing a CRT for the lives of some younger beneficiaries impossible.
What happens when you inherit an IRA from a parent?
Many people believe that they can roll over an inherited IRA into their own. You cannot roll an IRA into your own IRA or treat it as your own if you inherit one from a parent, aunt, uncle, sibling, or acquaintance. Instead, you’ll have to put your share of the assets into a new IRA that’s been established up and properly labeled as an inherited IRA for example, (name of dead owner) for the benefit of (name of deceased owner) (your name).
If your mother’s IRA account has more than one beneficiary, money can be divided into separate accounts for each. When you split an account, each beneficiary can treat their inherited half as if they were the only one.
An inherited IRA can be set up with almost any bank or brokerage firm. The simplest choice, though, is to open your inherited IRA with the same business that handled your mother’s account.
Most (but not all) IRA beneficiaries must drain an inherited IRA within 10 years of the account owner’s death, thanks to the Secure Act, which was signed into law in December 2019. If the owner died after December 31, 2019, this rule applies to inherited IRAs.
What is the 5 year rule for inherited IRA?
The method of distribution will be determined by the date of death of the original IRA owner and the kind of beneficiary. If the IRA owner’s RMD obligation was not met in the year of his or her death, you must take an RMD for that year.
For an inherited IRA from a decedent who died after December 31, 2019, the following rules apply:
In most cases, a designated beneficiary must liquidate the account by the end of the tenth year after the IRA owner’s death (this is known as the 10-year rule). During the 10-year period, the beneficiary is free to take any amount of money at any time. There are some exclusions for certain qualifying designated beneficiaries, who are described by the IRS as:
*A minor kid becomes subject to the 10-year rule once they attain the age of majority.
An eligible designated beneficiary can choose between the 10-year rule and the lifetime distribution rules that were in force prior to 2020 and are detailed in the section below titled “For an inherited IRA received from a decedent who died before January 1, 2020.”
Vanguard’s RMD Service does not support accounts that are being distributed based on the 10-year rule. If you’ve chosen to apply the 10-year rule for your inherited account or are forced to do so, you should consult your tax advisor if you have any issues regarding how to take distributions under this rule. If the account owner died before he or she was required to begin taking RMDs, a non-designated beneficiary (e.g., an estate or charity) would normally be subject to the 5-year rule (April 1st of the year following the year in which the owner reached RMD age). The non-designated beneficiary would be subject to an RMD based on the original IRA owner’s life expectancy factor if the IRA owner died on or after April 1st of the year following the year in which the owner achieved RMD age. Certain forms of trusts are subject to certain requirements.
For an inherited IRA from a decedent who died before January 1, 2020, the following rules apply:
When a beneficiary inherits an IRA from an account owner who died before the account owner was required to begin taking RMDs (April 1st of the year following the owner’s RMD age), the recipient has two options for distribution: over his or her lifetime or within five years (the “five-year rule”).
The major beneficiary is the spouse. If the owner’s spouse chooses to be a beneficiary of the IRA rather than assume the account, he or she can decide when to start taking RMDs based on his or her own life expectancy. By the later of December 31 of the year after the owner’s death or December 31 of the year the owner would have attained RMD age, the spouse must begin taking RMDs. The spouse beneficiary should wait until the year before he or she plans to start taking RMDs to enroll in our RMD Service. If the owner’s spouse decides to inherit the IRA, he or she must begin taking RMDs by December 31 of the year following the owner’s death or April 1 of the year after the spouse’s RMD age.
When a non-spouse is the major beneficiary, and when the spouse is not the sole beneficiary. By December 31 of the year following the owner’s death, an individual non-spouse beneficiary must begin taking RMDs based on his or her own life expectancy. If all of the beneficiaries have created separate accounts by December 31 of the year after the owner’s death and started in that year, they can take RMDs based on their respective life expectancies. If all numerous beneficiaries have not opened separate accounts by December 31, all beneficiaries must begin taking RMDs in the year after the owner’s death, based on the oldest beneficiary’s life expectancy.
Any individual recipient has the option of distributing the inherited IRA assets over the next five years after the owner passes away. The distribution must be completed by the end of the year in which the owner’s death occurs for the fifth time. If the owner died before taking RMDs, any non-individual beneficiary (excluding a qualifying trust) must use the five-year rule.
Vanguard’s RMD Service does not support accounts being allocated in accordance with the five-year rule. If you’ve chosen to apply the five-year rule for your inherited account or are forced to do so, you should see your tax advisor if you have any issues regarding how to take distributions under this rule.
Can an IRA be in an irrevocable trust?
While you’re alive, you can’t put your individual retirement account (IRA) in a trust. You can, however, name a trust as the IRA’s beneficiary and direct how the assets are handled after your death. This is true for all IRAs, including regular, Roth, SEP, and SIMPLE IRAs. If you wish to place your IRA assets in a trust as part of your estate plan, you need think about the characteristics of an IRA and the tax implications of particular activities.
How do I avoid paying taxes on an inherited IRA?
With a so-called Roth IRA conversion, IRA owners can transfer their balance from pre-tax to after-tax, paying taxes on both contributions and earnings. “If they’re in a lower tax bracket than their beneficiaries, it would probably make sense,” Schwartz said.
Are IRA’s part of your estate?
If you don’t name a beneficiary for your IRA, or if that person dies before you, a new picture emerges. Your IRA becomes part of your estate if you don’t name a beneficiary, and it must go through probate. If you specify your estate as the beneficiary, the same thing applies. You can avoid this by designating a second or contingency beneficiary to receive the IRA in the event that your first beneficiary passes away, and by ensuring that your beneficiary is an individual rather than an estate.
Can I transfer a stretch IRA?
Yes. You can transfer an existing IRA into your name and defer payouts until the Required Minimum Distribution is due (RMD). You can start an Inherited IRA if you plan to take a payout before you reach the age of 591/2. For further information, contact your tax advisor.