The Rubber Band is broken on “Stretch IRA’s”

One of the tax advantages of an individual retirement account (IRA) is that the beneficiaries of an IRA could stretch out the tax bill over the life expectancy of the beneficiaries.  In the meantime, the IRA could continue to grow tax deferred as long as the Required Minimum Distributions (RMDs) were paid out each year based on the beneficiary’s life expectancy.  That benefit is gone for decedents who pass away after 12/31/2019 with the passage of the SECURE Act (enacted as part of the 2019 budget bill).

Now the inherited IRA (whether traditional or Roth) must terminate after 10 years.  Federal and state tax will be due on the untaxed income in the traditional IRA.  The tax-free benefit of a Roth IRA also ends upon termination.

There are a few important exceptions in the SECURE Act, each of which qualify as an “eligible designated beneficiary”:

1. where the beneficiary is a surviving spouse,
2. a minor child of the owner,
3. a disabled or chronically ill individual (as defined), or
4. a beneficiary who is no more than 10 years younger than the deceased account owner.

An eligible designated beneficiary is allowed to continue the stretch provisions over their life expectancy, but following the death of an eligible designated beneficiary the account balance must be distributed within 10 years.  In addition, once a child is no longer a minor then the account must be distributed within 10 years.

The loss of the stretch IRA can wreak havoc on so called “conduit trusts” which were set up by estate planners to protect assets by taking out the RMD’s over the life of the beneficiary.   Unless the beneficiary is one of the eligible designated beneficiaries, the account must terminate after 10 years.

If the IRA is paid to an irrevocable trust, then the IRA could be taxed at a 37% federal tax rate; the tax rate on income over $13,150 (for 2020); state income taxes would be in addition!

Existing “conduit trusts” should be modified to deal with this new tax law.   One solution:  Design the conduit trust or an accumulation trust to terminate after 10 years, pay the associated taxes on the IRA for the beneficiary, and (with the consent of the beneficiary or her representative) then put the balance into a traditional discretionary trust for the benefit of the beneficiary.  Another option is terminate the conduit trust or accumulation trust at the 10 year mark, pay the taxes, and then purchase a non-cancellable annuity for the beneficiary. A third option is to pay over the IRA to a charitable remainder trust which could pay out a return based on the full amount over the beneficiary’s life expectancy since the trust will not pay any income taxes. The remainder will go to your favorite charity.  Finally, a trustee could terminate the trust and hope that the beneficiary is mature and savvy enough to invest the proceeds on their own.

The loss of stretch IRA provisions is estimated to raise $15.3 billion in additional tax revenue over the next decade.  A 10 year “stretch” is still a good deal for beneficiaries of an IRA but the rubber band beyond that time frame is now broken.

If you have estate planning or trust questions and need legal assistance, please contact Mr. Le Chevallier at info@buckley-law.com or visit our website at www.buckley-law.com.