When an Individual Retirement Account (IRA) is left to a nonspouse, a popular option to delay the payment of taxes is to spread out the account distributions over the lifespan of a younger beneficiary. Each year the beneficiary would have a Required Minimum Distribution, or RMD. The practice of stretching out the distributions, and as a result, the tax liability, has been nicknamed the “Stretch IRA”.
While the Stretch IRA (Stretch) doesn’t have quite the superhero powers that the name implies, it is a great for those that have worked hard all their lives and want to pass as much of their money to heirs with as little tax as possible. Delaying the taxes allows the funds to grow, increasing the legacy left to the beneficiary. As many of you know, MN Nice often highlights the power of time, capital market returns, and compounding.
If passed, the Secure Act would most likely act as a freeze ray to our intrepid superhero, killing it. The bill recently passed the House and is now in the Senate. Under the Secure Act, the balance of the Inherited IRA would have to be distributed within ten years of the IRA owner’s date of death allowing the government to get its tax dollars sooner rather than later. The accelerated tax collection could also move the beneficiary into a higher tax bracket. The Secure Act might more aptly be called the “Death In-Secure Tax Act”.
One of the Senate’s versions actually shortens the timeframe to five years, which really does put the beneficiary in a tax bind. Let’s hope they increase and not decrease the ten years. But the Senate does throw taxpayers a bone by excluding inherited accounts under $400k.
We will keep our fingers crossed and see what Congress concocts. But given the Stretch was almost killed back in 2013, its future seems dubious. Like a red-shirted security officer on Star Trek, I would not expect to see it around much longer. Stretch has just beamed down to the planet and Capitan Kirk has spotted his love interest and torn off his shirt. Better pay your respects now.
If Stretch dies, the owner must take extra care when managing assets and income. Looking closer at options like a Roth IRA, a Roth IRA conversion, claiming Social Security, the use of trusts and beneficiary designations, and when to access accounts may help preserve the owner’s legacy.
As the government gets creative with its attempts to raise revenues, without raising taxes, proactive fiduciary financial planning will be more important than ever