If you took the time to read the overly complex US tax code, you would find a phrase used, but nowhere in the tax code: The Stretch IRA. Like the back-door Roth IRA conversion, the stretch IRA was a strategy rather than actual tax code. Just as the 2017 TCJA changes eliminated the Roth re-characterization strategy, the Secure Act passed in December of 2019 eliminated the Stretch IRA strategy.
Recognizing that previous strategies can be altered or eliminated becomes critical when planning today. You can’t simply check things off on your tax planning strategy. The tax code is ever-changing and constant updating and reviews are required. Beneficiaries will be affected by the tax code change. The potential negative impact will increase when the person leaving the gift didn’t understand the severity of the change.
There are three primary types of beneficiaries for IRA’s: your spouse, your family or your charity. IRA’s don’t need to pass through a Will because they include a beneficiary designation. If your beneficiary is a charity, the Secure Act had no impact on your election. If it is your spouse, there is no change. However, your children and other non-spouse persons have a surprise coming if they are named as a beneficiary.
Prior to the change, your non-spouse heirs had to take a Required Minimum Distribution (RMD) every year based on their life expectancy if you died prior to turning age 70.5. If you were over 70.5, they began to take RMD’s based on your remaining life expectancy. Yes, deceased people do have a life expectancy chart provided courtesy of the IRS. Hence, the name the “Stretch IRA.” They could stretch out the income they received for years to come. This was especially beneficial in Roth IRA’s where no taxes were do on the distribution or future growth. Those days have passed.
Under the Secure Act rules, your non-spouse beneficiaries don’t have any RMD requirements at all. However, the beneficiary is required to withdraw the entire balance by the end of the 10th year. This includes Roth type assets. This complicates existing trusts documents and estate planning strategies.
Beneficiaries generally have one of two types of behaviors: Those who spend everything the movement they are provided the opportunity, and those who will let the money grow if possible. The spend-thrift will have no impact from the change. The frugal savers will likely be hit with a very large tax bill years into the future when the account has mandatory distributions.
Your “Next Steps” (our financial planning process) is assessing what you want for your beneficiares. You know who will likely save the inheritance and who will spend it quickly. The ideal strategy for those two types of beneficiaries may be extremely different. Your estate planning and beneficiary designations need to be examined and aligned with your wishes and what is allowed by law. The tax code continually changes, and it will impact you and your heirs. Be ready.
Joseph A. Clark is a Certified Financial Planner and Managing Partner of The Financial Enhancement Group, an SEC Registered Investment Advisor. Joe can be reached at yourlifeafterwork.com or 800-928-4001. Securities offered through World Equity Group, Inc. Member FINRA/SIPC. Advisory services can be provided by Financial Enhancement Group (FEG) or World Equity Group. FEG and World Equity Group are separately owned and operated. World Equity Group does not provide tax advice.