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The Demise of the Stretch IRA

Other solutions to keeping it all in the family.

Christine Benz: Hi, I'm Christine Benz for Morningstar. The SECURE Act, passed in late 2019, brought about the demise of the so-called "stretch IRA." Joining me to discuss the implications for tax and retirement planning is tax and retirement expert, Ed Slott. He is the author of a new book called The New Retirement Savings Time Bomb.

Ed, thanks for being here.

Ed Slott: Great to be back. Thanks, Christine.

Benz: Ed, let's talk about the stretch IRA, but first talk about what that was and also I'd like to hear about how many people actually took full advantage of this stretch IRA. Do you have any way of knowing?

Slott: I don't know how many people took advantage of it. We've talked about it for years. In fact, I remember when it first came out. It's not a real thing; it's just the name given to it. I remember many years ago, when this first started, I had a client. I told him about it. He called me. He said, "I'm at the bank. You said get a stretch IRA. They don't have them." It's not a product, it's a process. It's just the ability--or was the ability before 2020--of you naming a beneficiary, maybe a younger one, a child or grandchild, and they could stretch, or extend distributions, out over their own life expectancy, 50, 60, 70 years for a young grandchild. Congress thought that was too great of a gift, and what they did in the SECURE Act, they eliminated it and replaced it with basically a 10-year rule for most nonspouse beneficiaries. Spouses are unaffected. There are a few other exceptions, but generally, a spouse--you don't have to worry; you're unaffected. The same rules apply to you.

So, now, in general, the way this new 10-year rule works--if somebody died, in 2020, because that's when it was in effect. You know, most people forgot about this because, look what happened in 2020--we had the pandemic, the CARES Act, all these tax relief provisions, and a stimulus at the end of the year. And most of that ended in 2020, but the SECURE Act is still here. So, that was effective for deaths beginning in 2020. So, if you inherited as a nonspouse--a child or a grandchild--you would be stuck with a 10-year rule, which means the entire inherited account would have to be withdrawn, even if it was a Roth, by the end of the 10th year after death.

Benz: Unaffected by this would be people who are spouses. Let's talk about that when spouses inherit an IRA from another.

Slott: Well, I equate the spouse in tax law to the queen in chess. Spouses can do anything. Most tax law protects spouses. So, they were the number-one exemption. There are five exemptions, but that's the main one because most people leave their IRA--most married people leave their IRA to their spouses. So, they're unaffected. They could still do the same things they could before the SECURE act, like it never happened. They could do a rollover; they could remain a beneficiary if they want. A young spouse might want to do that if they need access to the funds, and they inherit before 59.5--that could help them avoid the 10% early distribution penalty--and then do a rollover whenever they want. So, they still have all of those options. The problem is, even with a married couple, somebody is going to die first, and then you're right back where you started. Then you have a single person, unless they get remarried, that leaves it to a child or grandchild. At some point, it's going to go to that 10-year rule. And the Congress, by doing that, is going to cause the taxes to be accelerated in that 10-year period when some beneficiaries might even be in their own high earnings years and maybe at higher rates at that point.

Benz: The 10-year window does give inheritors a little bit of latitude to decide when within that window to take their distributions, right? They could wait until all the way to the end or earlier depending on their situation?

Slott: Yeah, it's not a bad rule, actually. It gives you maximum flexibility. When we had the stretch before, you had to take a certain amount, even if it was a small amount, every year for all the years. There's no more annual RMDs, required minimum distributions, anymore. Now, there's only one RMD. Whatever the balance is, at the end of the 10th year, that has to come out. But watch it, at the end of the 10th year, if it's anything remaining in there, not only has to come out, if it doesn't, it's subject to the current 50% penalty for not taking an RMD.

And you mentioned before how many people actually stretch. I don't even know if that many beneficiaries did--you know, it's very tough for a beneficiary to keep their hands off money. Imagine telling a 30-year-old, "Just take a little drop for the next 50 years." Highly unlikely you're going to see that happen. As a matter of fact, with this 10-year rule, some of them that might have taken it in one or two years, thinking it's better, "Oh, I can wait 10 years? I wasn't going to wait that long." And especially, if you inherit a Roth, that's the time you want to wait the 10 years, because if you can keep your hands off it for 10 years, all the time, it's growing, it's growing, accumulating tax-free until you actually have to take it out by the end of the 10th year after death.

Benz: You mentioned Roths. I think people sometimes forget, Ed, that those, too, are subject to RMDs when they are inherited by other people.

Slott: Right. And again, no annual RMDs, the 10-year rule. So, the great part about this 10-year rule, whether it's Roth or a regular IRA: The beneficiary can time the distributions. They can take whatever they want.

Let's take an example. Let's say a beneficiary inherits, I don't know, at age 60--parent dies, and they're going to retire in about three years. Well, maybe for the first three years, they don't touch anything because they are still in a high bracket, and then they start taking it when they're in lower brackets in years seven, eight, nine, and 10, maybe. So, you have a lot more planning flexibility with this 10-year rule. There's no requirement to take anything in a particular year, as long as it's emptied by the end of the 10th year.

Benz: There's been a lot written since the SECURE Act and the death of the stretch IRA--about workarounds that people can use if they want their loved ones to be able to take advantage of their assets, to receive some tax benefits on their assets. What would you say to people who are doing some planning who want to be able to leave as much as they possibly can to their loved ones and to have them take advantage of tax deferral? Are there any strategies they should consider?

Slott: Yes. Well, the ones most affected are the people obviously with the largest IRAs because there's more of a chance that more of that balance will be left over to beneficiaries. So, one strategy is with permanent life insurance. And just so know if you're listening--I don't sell life insurance. I'm a tax advisor. But IRAs were severely downgraded by the SECURE Act. That's what Congress meant to do. They said, "No more IRAs. Retirement accounts should be for retirement, not for wealth transfer or estate planning." So, they killed the stretch and replaced it with the 10-year rule. It might pay. If you want--the three things that every client I ever had wants, you can get them with life insurance. The three things: They always said, "I want larger inheritances, more control, and less tax." You can get that by taking that large IRA down now at low rates. Take advantage of low rates, now that the funds are bought and paid for. You can put that into a permanent life insurance, like a cash value life insurance that builds cash value tax-free. That can be left to beneficiaries either directly or in a trust where you can get that postdeath control. It could simulate the stretch IRA, plus, the distributions don't have to be taken on a schedule. There's no RMDs, no complicated tax rules, and best of all, no tax. So, it can stay protected in the trust or not. You can get the plan you actually want. It's not for everybody, but it really works well for those who have large IRAs and still want that large inheritance to their children with low taxes or no taxes.

Benz: Some people may be struggling with whether their beneficiaries should change as a result of this change. I like your point on this topic where you say the person you want to inherit your IRA should inherit your IRA and that you shouldn't get too caught up in the tax maneuvering.

Slott: Right, I believe that. I always ask people, "Who do you want to inherit the IRA?" That will drive the plan. I wouldn't say, "Don't leave it to your son, you know, leave it to this." Or "don't leave it to your wife, don't leave it to your husband because of taxes." That's not going to fly. You have to have the plan you want, and you work around that. Now, you might change some plans. For example, I see some people updating their beneficiary forms and estate plans. I've been hearing some people, they want to, for example, they might have two children and they were always doing everything equal. But one is doing really well and the other not so much, and they might change the equation. Maybe leave the one who needs more more and divvy up with other assets. So, I'm seeing some things like that but not outright changing beneficiaries for tax reasons.

Benz: Ed, it's always great to get your perspective. Thank you so much for being here.

Slott: Thanks, Christine.

Benz: Thanks for watching. I'm Christine Benz for Morningstar.