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Replace the Stretch IRA?

Today's rules have created a lottery system, and those under consideration in Washington would only make things more complicated.

Natalie Choate, 09/08/2017

Under today's law, a beneficiary who inherits an IRA (or other tax-favored retirement plan) has the option to continue the tax-deferred status of the benefits by electing a "life expectancy payout." Code section 401(a)(9) requires the beneficiary to take annual "required minimum distributions" over his life expectancy. Except for this annual distribution, the IRA can stay in its tax-deferred state for years or even decades, depending on how old that beneficiary was when she inherited the account. A newborn beneficiary could achieve an 80-year deferred payout!

This "life expectancy payout" system is great ... for a few people. Namely, the few beneficiaries who are lucky enough to inherit an IRA that was properly set up for them to qualify for the life expectancy payout, and who are young enough to have a long life expectancy to "stretch" the payments over, and who are knowledgeable enough to take advantage of it.

But what about the rest of us? As it turns out, unfortunately, most IRA owners and beneficiaries do not benefit from the "stretch," because:

>The life expectancy payout is available only if the deceased IRA owner named the individual as his "designated beneficiary." Many participants flub this step, causing their retirement benefits to pass to their estate rather than directly to family members. When benefits pass to an estate, the life expectancy payout is not available. Beneficiaries are stuck with at best a five- or 10-year payout.

>A trust named as beneficiary can qualify for the life expectancy payout under IRS rules--but only if it meets stringent IRS requirements. Experience has taught that few estate planning practitioners have mastered these requirements. Even the IRS doesn't seem to understand the rules, since they've issued contradictory rulings interpreting them.

>Most IRA owners are old when they die, so their beneficiaries tend to be older also--it is actually rare for an IRA to be left to a young individual who would qualify for a multidecade payout.

>Even when the stretch payout is an option, many beneficiaries prefer an immediate cashout over a deferred payout.

In short, today's rules have created a lottery system; the payout period for your IRA depends on such wild cards as how old your beneficiaries are, how good your estate planning lawyer is, and whether you remember to fill out a beneficiary designation when you move your IRA to a new company.

Natalie Choate practices law in Boston with Nutter McClennen & Fish LLP, specializing in estate planning for retirement benefits. Her book, Life and Death Planning for Retirement Benefits, is a leading resource for professionals in this field.

The author is not an employee of Morningstar, Inc. The views expressed in this article are the author's. They do not necessarily reflect the views of Morningstar. The author is a freelance contributor to MorningstarAdvisor.com. The views expressed in this article may or may not reflect the views of Morningstar.

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