A stretch IRA was a way to limit required distributions on an inherited IRA, avoiding a sizable tax bill in the process. Instead of naming a spouse as the IRA’s beneficiary, an account holder could name children, grandchildren or great-grandchildren. Doing so stretched the lifespan of the IRA, extending its tax-deferred growth for years or decades beyond the life of the original account holder. However, the stretch IRA was eliminated in 2019 when the SECURE Act was passed.
How the Stretch IRA Worked
Say you diligently saved for retirement for decades and your IRA made it into six figures. If you didn’t expect to spend down your entire IRA in retirement, the stretch IRA was one option for making the money last longer for your heirs.
The rules for inherited IRAs are different for spouses and non-spouse beneficiaries. As a spouse who inherits an IRA you can either roll over the funds to your own IRA or wait to take required minimum distributions (RMDs) until your late spouse would have reached RMD age. If you have other income you may want to wait to take RMDs so that your tax bill is lower.
But what about non-spouse beneficiaries? The IRS had stricter rules for non-spouse heirs. These beneficiaries had three options:
- Take the money and run. This means emptying the entire inherited IRA and paying taxes on that sum in one go.
- Stretch withdrawals with RMDs. The IRS required non-spouse beneficiaries of IRAs owned by people over age 70.5 to start taking RMDs within a year of inheriting the IRA. However, those RMDs were based on the beneficiaries’ life expectancy. The younger you are, the lower your RMDs.
- Empty the account within five years. You didn’t have to stick to the RMDs or take all the money from the IRA at once. You could wait and take any sum you want, but once you started taking distributions beyond your RMDs you had to finish emptying the account within five years.
The stretch IRA took advantage of the fact that younger beneficiaries have smaller RMDs since they have longer life expectancies. With a stretch IRA, account holders could name their youngest relatives as beneficiaries. Well-to-do folks who know that their spouses have enough money to get by could preserve and extend their family’s fortune by naming children, grandchildren and great-grandchildren as IRA beneficiaries. Those younger relatives then could take RMDs that are small enough to trigger minimal taxes. The rest of the inherited account could then continue to grow tax-deferred and increase in value. It was a form of inter-generational wealth transfer with serious tax advantages.
If you weren’t comfortable bypassing your spouse as your IRA beneficiary you could instruct him or her to stretch it for you. With this strategy, you would have named your spouse as your IRA beneficiary. He or she would then roll your IRA into an inherited IRA in his or her name and start taking RMDs when required. Your spouse would then name a member of the younger generation as the IRA’s beneficiary. When your spouse dies, the young beneficiary would start taking the small RMDs described above.
Elimination of Stretch IRA
However, the stretch IRA was discontinued as part of the SECURE Act in 2019. The law, which ushered in some big changes to the way Americans save for retirement, replaced the stretch IRA with a 10-year distribution requirement. Now, IRA beneficiaries must empty the inherited account by the end of the 10th year after the original owner’s 10th. However, the new rules don’t apply to the IRAs of people who died before 2020.
When pondering your estate planning needs and strategy, keep this rule in mind: the more you have, the more you should plan if you want to limit your family’s tax liability. Many families consider themselves lucky if they can retire at all. More and more seniors are still dealing with student debt in their golden years. If you’re lucky enough to reach retirement with plenty of money to spare you’re living the dream.
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