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The Uncertain Future of the "Stretch IRA"

Under current law, when an heir inherits a Roth IRA or an IRA from someone who has not yet begun receiving minimum distributions, he or she must make a choice. The money must be distributed either within five years or over the heir’s lifetime. For lifelong distributions, the heir will need to withdraw a minimum amount each year based upon IRS life expectancy tables. This strategy is referred to by estate planners as a “Stretch IRA.”

For a young heir, such as a child or grandchild, stretching payments over a lifetime and maximizing the period of tax deferral, can make an enormous difference in the total value of this financial resource. That’s because in the early years, the required minimum distributions are likely to be less than the growth in the value of the account, which allows for additional tax-free accumulations.

Retirement and Enhancement and Savings Act of 2016

In the June edition of Trust & Estates magazine, James Lange explores the alternatives for a 46-year-old heir inheriting a $1 million traditional IRA. Assuming a 7% rate of return, if the heir only takes the minimum distributions for life, the account will peak at about $2.7 million (age 76), and it will be worth $2.5 million when he is 82 years old.

On the other hand, if the account is fully-distributed within five years and subjected to ordinary income taxes, and the proceeds are placed in a taxable portfolio, the same pattern of withdrawals will exhaust the account when the heir is 82 years old.

Too Good to Last?
Last year, the Senate Finance Committee voted unanimously for the Retirement Enhancement and Savings Act of 2016. One critical “enhancement” was the elimination of the vast majority of stretch IRAs in the future.

Under the new bill, nearly everyone will have to abide by the five-year rule for inherited IRAs and lump sum death benefits from qualified retirement plans; there are exceptions for surviving spouses and disabled dependents.

If a beneficiary is a minor, the five-year distribution rule would not kick in until he or she reaches the age of majority; there are also exceptions for charities, charitable remainder trusts, and beneficiaries who were born within ten years of the account owner.

Not So Simple
The bill also carves out the first $450,000 in IRA assets from the application of the five-year rule. Therefore, a new wrinkle will be added to estate planning.

In estates in which combined IRA balances are less than $450,000, no change of plans will be needed. Estates with larger IRAs may need to be reviewed and new plans devised, if the new rules are adopted.

Given the unanimous vote, the elimination of the stretch IRA has bipartisan support. On the other hand, the bill died last year, and has not been reintroduced yet.

Will there be tax reform this year? One of the difficulties of developing a consensus for a tax reform bill is the need to “pay for” tax cuts with other tax increases. The stretch IRA is a low-hanging fruit that looks ripe for harvest by eliminating it. The Joint Committee on Taxation scored the provision as raising $3.8 billion over the next ten years. But if tax reform gets pushed into 2018 (the most likely outcome right now), the stretch IRA remains safe for another year or so.

Do you have questions concerning wealth management? If so, send them over to Adam Cox, JD, MBA, and he’d be happy to help.

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