A Break on Inherited IRAs Could Disappear
Congress takes aim at the so-called stretch IRA.
The SECURE Act recently passed by the U.S. House of Representatives is full of retiree-friendly provisions. But one is irking a number retirees who were hoping to pass on money accumulated in an IRA to their heirs: the end of the “stretch IRA.”
This estate-planning tool allows non-spouse heirs to inherit an IRA and “stretch” withdrawals over their life expectancy—meaning that they could leave much of the money in the account to grow tax-deferred for decades. (If it’s a traditional IRA, they’ll pay taxes on the withdrawals; if it’s a Roth, they’ll pay no taxes.)
But under the SECURE Act, most younger heirs would have to withdraw the money within 10 years. Lawmakers seemed to believe that IRAs are supposed to be used for retirement, not as estate-planning vehicles, says Ed Slott, founder of IRAHelp.com. “But changing the rules of the game is not fair to savers.”
Many IRA owners agree. “Nonspousal beneficiaries will be denied the benefit of long-term growth opportunities in their inheritance,” observed Don Burrell, a retiree from Rochester, N.Y., in an e-mail to Kiplinger’s, “thus reducing the ability to fund their retirement, ironically one of the key objectives of the Act.” His daughter may inherit an IRA someday.
The Senate was expected to pass the bill shortly after the House, but the timing is now uncertain. If it’s signed into law, the new rule would affect heirs who inherit IRAs starting next year—not those currently drawing from stretch IRAs.
Besides spouses, the SECURE Act exempts heirs from the 10-year rule as long as they are no more than 10 years younger than the account owner, as well as minor children and those who are chronically ill or disabled. Once minors reach the age of majority—usually 18—the 10-year countdown kicks in.
If the provision becomes law, there are other ways to reduce taxes on an inherited IRA. Some strategies:
Switch to life insurance. Money can be gradually withdrawn from a traditional IRA at today’s lower tax rates and used to buy a permanent life insurance policy, whose death benefit won’t be taxable, Slott says.
Change beneficiaries. Instead of leaving an IRA to a younger beneficiary, you could leave it to a spouse, who is exempt from the 10-year rule. Or you could designate more than one beneficiary on a traditional IRA. The withdrawals for each will be smaller—and so will the tax bite.
Convert to a Roth. If future tax rates are expected to be higher for heirs, consider gradually converting money from a traditional IRA into a Roth. You’ll owe taxes on any untaxed earnings and contributions that are converted, but later withdrawals from the Roth won’t be taxed.
Use a charitable remainder trust. You could also leave a traditional IRA to a charitable remainder trust, which would pay a regular income to your beneficiary for life or a certain period. Once the beneficiary dies, the remaining money goes to the charity.