Preparing for retirement is essential to ensure you have a nest egg large enough to support you well into your golden years. Retirement plans are a big part of that. However, I run into clients all the time who are only taking their required minimums and don’t even spend it. They are planning on passing it along. Extending your wealth to the next generation may provide you with some motivation to start planning now.
A stretch IRA was a great tool that could allow your beneficiaries to pull income on tax-deferred investments for the rest of their life. While still around, there are new stretch IRA rules that govern the continued use of this part of your estate planning.
Here is what you need to know about the stretch IRA, who can use it, and the rules that govern it.
What is a Stretch IRA?
While it is no longer an option for those who are looking ahead, the stretch IRA was a powerful tool in your estate planning strategy. But what exactly is a stretch IRA, and why were so many sad to see it end?
A stretch IRA allowed anyone with an individual retirement account (IRA) to contribute assets to the account and then pass those savings along to a beneficiary in another generation. The benefit of this strategy was that the account prolonged the tax-deferred status of your assets for someone named as a beneficiary.
In other words, your beneficiary could start taking distributions from the stretch IRA upon your death. This allowed your beneficiary to pull a steady stream of income and build long-term wealth based on your financially savvy planning.
Unfortunately, the stretch IRA was essentially disallowed by the SECURE 2.0 Act in 2019. However, those who were still beneficiaries of an active stretch IRA retained the benefits of the strategy. There are some rules that govern the continued use of stretch IRAs for beneficiaries named as an eligible designated beneficiary in certain scenarios.
Who Can Still Use Stretch IRAs?
Not everyone is permitted to utilize a stretch IRA in the post-2019 world. Now, a beneficiary must qualify under the title of Eligible Designated Beneficiaries. This category is quite specific and can encompass five potential ways that someone could inherit a stretch IRA.
Those five types of people include:
- Surviving spouses
- Minor children of the account owner
- Beneficiaries with a disability
- Beneficiaries with a chronic illness
- Beneficiaries who are less than ten years younger than the account owner
In most cases, this means that the Eligible Designated Beneficiary (EDB) can receive distributions from the stretch IRA over the course of their single life expectancy. Be warned that some of the titles, including those with a disability or chronic illness, will be required to prove their status.
For those who don’t meet the EDB status, there are other rules that may have sway in the release of payments.
What is the 10-Year Rule?
In lieu of the stretch IRA provision, SECURE 2.0 stipulated a new rule that limits how long an EDB can receive distributions. This new rule, known as the 10-Year Rule, should be factored into your estate planning. What can you expect from this provision?
The 10-Year Rule applies to beneficiaries other than surviving spouses, and the function of it is quite simple: If you inherit an IRA, you must withdraw all funds in the account before the end of the tenth year after the death of the account holder. Not so bad, right? Wrong; these payments come as taxable ordinary income stacked on top of your other normal taxable income, potentially sending you into the top tax bracket. That’s the plan, anyway.
Of course, special rules apply to surviving spouses. A surviving spouse has the unique option to treat an inherited IRA as their own, allowing them to delay distributions or take them over their own life expectancy, or to keep it as an inherited account and use the 10-year rule, where all assets must be distributed by the end of the tenth year after the original owner's death.
While an IRA can still be a powerful tool for retirement savings and estate planning, this new rule makes it harder to pass along generational wealth.
Charitable Remainder Trusts can also replace the Stretch IRA, since they provide tax benefits while also allowing beneficiaries to receive distributions for decades to come.
Consult with Magellan for Estate Planning
Estate planning is a complex endeavor that requires time and careful attention to detail. Magellan can offer comprehensive estate, legal, financial, and tax planning all under one roof so that you get the help you need to provide for the next generation. If you are wondering what to do in place of a stretch IRA, Magellan can help.
Contact us today for more information on how you can pass along wealth to your beneficiaries.
For a comprehensive review of your personal situation, always consult with a tax or legal advisor. Neither Cetera Advisor Networks LLC nor any of its representatives may give legal or tax advice.
This material provided by Kevin Meaders was written by Axle Eight, a non-affiliate of Magellan Planning Group and Cetera Advisor Networks LLC.