The stretch IRA is dead, so what options do you have when it comes to inheritance planning?
At the start of 2020, new rules were introduced on how individual retirement account (IRA) holders can use the “stretch” IRA to manage their inheritance. With changes to the way beneficiaries access inheritance assets, you may have questions about what the rules mean for you and your loved ones.
In this post, we look at what happened to the stretch IRA and how it could affect your inheritance planning. We also cover some of the alternatives to stretch IRAs, including life insurance and Roth conversions.
What happened to the stretch IRA?
On January 1, 2020, the Secure Act was passed and with it came to the end of the stretch IRA. For years, this estate planning strategy was a tax-advantageous way to leave an IRA to a non-spouse beneficiary, but now it’s no longer an option.
So, which new rules were introduced under the Secure Act 2020? And what effect have they had on how IRAs work?
The biggest change concerns how a beneficiary can access an IRA after they’ve inherited it. Previously, a stretch IRA allowed non-spouse beneficiaries unlimited time to withdraw funds from their inheritance. Now, the money must be out of the IRA within 10 years after the date of death, so beneficiaries can no longer access them over their lifetime.
Say, for example, you want to leave $40,000 to your grandchild, who is 30 years old. The Secure Act now means they must withdraw all of the assets within 10 years, either as a lump sum or as annual distribution payments. If they don’t, they’ll have to pay tax all at once, which could significantly reduce their inheritance pot.
Thankfully, the introduction of the Secure Act isn’t all bad news for those with an IRA. There are two other rule changes which many will see as a benefit:
- The age at which you must withdraw required minimum distributions (RMDs) from your IRA has risen from 70 to 72. This means you’ll have two more years to pay into your retirement account before you need to start drawing money from it.
- The Secure Act has removed the upper age limit of paying into an IRA. Now, so long as you’re still earning income, you can continue paying into your retirement account indefinitely.
What to consider when withdrawing from an IRA inheritance fund
Now that beneficiaries have just 10 years to withdraw assets from an IRA, they must think about how and when to access their inheritance. Remember, a beneficiary can withdraw funds either as a lump sum or as regular distributions, affecting how much they pay in tax.
If a beneficiary is 60-65 and within 10 years of retirement, it could be worth waiting until they retire before withdrawing money from the IRA. That’s because retirement means a smaller income, so they’ll be in a lower tax bracket and pay less tax on the total inheritance amount.
For younger beneficiaries, withdrawing from an IRA over the 10-year period may be more advantageous – especially if they expect their income to increase as they get older.
Through these examples, you can see why it’s important for beneficiaries to think about the best time to withdraw funds from an IRA. We’d always recommend discussing these options with your beneficiaries so that they can make the most of their inheritance after you’ve gone.
How to manage your inheritance now that the stretch IRA is gone
Now that the stretch IRA is a thing of the past, what other options can help you make the most of your inheritance?
With advanced IRA planning, you can make sure your beneficiaries don’t face a heavy tax burden on their inheritance. There are a few different options that provide good alternatives to the stretch IRA, including Roth conversions and life insurance.
A Roth conversion is the process of switching your pre-tax IRA assets into tax-free ‘Roth’ assets. This means that you pay the tax on your beneficiary’s inheritance so that all the money they receive is tax-free.
The beauty of Roth assets is that, while the 10-year Secure Act rule still applies, there’s no tax to worry about for both lump sum and annual withdrawals. What’s more, as Roth assets earn interest, it’s well worth letting the inheritance grow over the 10-year period.
A Roth conversion does mean you’ll have to settle the tax bill yourself, passing this benefit to your beneficiary. If that’s important to you, it could be a great option.
The second option we’d recommend as an alternative to the stretch IRA is life insurance. Although slightly more complicated than a Roth conversion, taking out life insurance guarantees tax-free inheritance for your beneficiaries after you’ve gone.
A key thing to note about the life insurance option is that you have to go through underwriting, meaning you first have to qualify. Some people may be concerned that their age will bar them from taking out life insurance, but you may be surprised at the rates and options available.
Life insurance is a great way to ensure your non-spousal beneficiaries can enjoy their inheritance without worrying about tax. What’s more, there’s no 10-year rule on when an inheritor has to withdraw the funds from a life insurance plan, making it a beneficial long-term inheritance option.
So, if you have money set aside as inheritance, life insurance could be the best way to guarantee a tax-free benefit for your loved ones.
Do you need help with your inheritance planning?
We understand that planning your inheritance can be complicated, especially given the recent rule changes introduced by the Secure Act. So, if you need help understanding the different options available, our experts can provide impartial advice on the best way to pass your retirement assets on to your loved ones.
Whatever you’re planning for your inheritance and however big the sum you’ve set aside for your beneficiaries, we can help make the process simpler to manage. Book a complimentary 15-minute call with a member of our team to discuss your retirement goals today.