The SECURE Act: Dealing with Loss of the “Stretch” IRA

By Jim Terwilliger

Earlier this year, we reviewed key elements of the SECURE (Setting Every Community Up for Retirement Enhancement) Act of 2019.

One of the law’s 29 provisions eliminates “stretch” IRAs and mandates that inherited IRAs for most non-spouse beneficiaries be distributed within 10 years following the year of the IRA owner’s death. This applies to both inherited traditional IRAs and Roth IRAs. Previously, beneficiaries could stretch required minimum distributions (RMDs) over their expected lifetimes while the investments continue to grow tax-deferred or for Roth IRAs, tax-free.

Beneficiary exemptions are spouses, minor children until reaching age of majority, those who are chronically ill or have special needs, and those within 10 years of the original IRA owner’s age.

Otherwise:

• If the IRA owner died in 2019 or earlier, a non-spouse beneficiary is covered by the old rules. While the beneficiary must take RMDs, the inherited IRA can continue to be stretched over the beneficiary’s life expectancy.

• If the IRA owner dies in 2020 or later, the new rules are in place. Unless one is an exempted beneficiary, RMDs are no longer required but the inherited IRA must be distributed fully within 10 years.

So, what is the big deal?

It is not a big deal for beneficiaries who empty their inherited IRAs quickly, which, of course, is allowed. But it is for beneficiaries who are responsible stewards of their inheritances. Forcing non-exempt heirs to empty their inherited IRAs within 10 years may put them temporarily into a high tax bracket, particularly if they are still working during that 10-year timeframe. Net after-tax proceeds can be subsequently diminished.

It can also be a big deal for IRA owners who name a trust as beneficiary. In many such cases, the trust is designed to meter out RMDs to heirs over their lifetimes. With the new rules, there are no RMDs. With other trust designs, distributions are taxable to the trust, not the beneficiary. Trust income tax schedules are highly aggressive and will now subject trusts to these high tax rates over a short 10-year timeframe.

So, what is one to do? Enter planning opportunities that provide workarounds to the new inability to stretch inherited IRAs over time. Let’s take a look at three of them:

Build up your Roth IRAs

A powerful workaround to dampen the loss of the “stretch” is to shift your portfolio to minimize traditional IRA/401(k) pre-tax holdings in favor of maximizing Roth IRA/410(k) tax-free holdings. This can be accomplished by shifting your savings practices if you are still working and/or performing partial annual Roth conversions during your relatively-low tax-bracket years between retirement and age 72, the new age when RMDs are now scheduled to start. This is even more powerful if you delay starting Social Security benefits until age 70. The key is to limit annual taxable conversions to keep you within your current tax bracket.

Doing the above increases the inherited Roth/traditional IRA ratio for your heirs. While inherited Roth IRAs must also be emptied in 10 years, the tax hit is zero since Roth distributions are non-taxable. Inherited Roth IRAs can be “stretched” by transferring the full tax-free value of an inherited Roth account to a taxable investment account at the 10-year point which can then appreciate at lower long-term capital-gains tax rates.

Use of Disclaimers by Spouse Beneficiaries

Here, a spouse names the other spouse as sole primary beneficiary of a traditional IRA and children as contingent beneficiaries. When the first spouse dies, the survivor can elect to disclaim a portion of the IRA, which automatically directs that portion to the children. Finally, when the survivor dies, the children will inherit whatever is left, starting another 10-year clock. This sequence can “stretch” out the children’s two inherited IRAs for up to 20 years combined.   

Charitable Remainder Trusts (CRTs) as IRA Beneficiaries

This workaround should only be considered if the IRA owner has charitable interests. Here, the owner names a CRT as a partial or full primary beneficiary of a traditional IRA. The trust document can provide, say, for a child or children to receive taxable distributions from the trust over their lifetimes. When the children ultimately pass, the remainder value of the trust transfers tax-free to charity.

The IRA owner accomplishes two objectives: 1) provide “stretch” distributions to the children over their lifetimes, and 2) provide a potentially substantial legacy to one or more charities.

If you have an IRA or 401(k), sit down with your attorney and financial planner to determine if your estate plan needs to be revised because of the SECURE Act.

Do it so sooner rather than later.

James Terwilliger, CFP®, is senior vice president, senior planning adviser at CNB Wealth Management, Canandaigua National Bank & Trust Company. He can be reached at 585-419-0670 ext. 50630 or by email at jterwilliger@cnbank.com.