3713.08 / What types of estate planning strategies can individuals use to replace the “stretch” IRA post-SECURE Act?

After the original SECURE Act was signed into law, taxpayers and advisors quickly realized that the inherited IRA had lost a key quality: the ability for beneficiaries to stretch the associated tax liability over their lifetime.  The IRS further limited the tax deferral benefit by releasing proposed regulations that require beneficiaries to take taxable distributions each year.  Now, many individuals are searching for alternatives to replace the so-called “stretch” IRA.

 Before the SECURE Act became law, inherited IRA beneficiaries could stretch the tax liability associated with these accounts over their own life expectancy.  Post-SECURE, only eligible designated beneficiaries (EDBs) have that option.  EDBs include (1) surviving spouses, (2) disabled or chronically ill beneficiaries, (3) beneficiaries who are not more than ten years younger than the original IRA owner and (4) the original IRA owner’s minor children (until they reach age 21).

All other beneficiaries must empty the account within ten years of the original IRA owner’s death (paying ordinary income taxes on those distributions).  Before the IRS released proposed regulations, most experts believed that beneficiaries wouldn’t have to take RMDs during the first nine years, leaving the option of deferring all taxes until year 10.

The regulations changed that rule for beneficiaries of IRAs where the original owner died after his or her required beginning date (the date RMDs began).  Those beneficiaries are also required to take annual RMDs during years 1-9 after the original IRA owner’s death.  Any remaining amounts must be distributed in year 10 (the IRS granted relief through 2024).

Roth Conversions

 The SECURE Act regulations make Roth conversions more appealing for beneficiaries.  However, the SECURE Act also modified the rules governing inherited Roth IRAs.  Those beneficiaries will now be required to empty the account in ten years if they do not qualify as an EDB.

Roth IRAs are still appealing despite the change because Roth IRAs are not subject to RMD rules during the original IRA owner’s life.  Roth IRA beneficiaries must take RMDs after the original owner’s death—but that owner will always be deemed to have died before their required beginning date because a Roth can never go into pay status because there is no required beginning date (i.e., the original owner did not have to take RMDs during life in the first place).

Any Roth IRA beneficiary can wait until year ten to empty the account—allowing the funds to grow tax-deferred for another ten years.  Of course, those funds are nontaxable because the original account owner paid taxes on Roth contributions during life, but the earnings will be tax-free as well.

It is possible to minimize the original owner’s tax liability by executing Roth conversions after retirement, when the taxpayer may have entered a lower income tax bracket.

The Charitable Remainder Trust Option

Clients might also consider establishing a charitable remainder trust (CRT) and naming the CRT as their IRA beneficiary.

The CRT is an irrevocable trust that will provide income to the beneficiary each year, whether for life or over a predetermined term of years.  The amount of income received is based on the value of the assets the client has passed to the CRT (the amount is re-calculated each year).  At the end of the term, the remaining account value is paid to a qualified U.S. charity (the CRT must be structured so that the charity receives at least 10 percent of the donor’s contribution).

The account owner’s estate will receive an estate tax deduction for the charitable gift.  The CRT distributions to beneficiaries are taxed as ordinary income.  On the other hand, using the CRT to distribute funds over the beneficiary’s lifetime gives the assets more time to grow, so that the heir’s overall inheritance may be larger in the end.

Life Insurance

If the taxpayer has already passed their required beginning date and are taking RMDs, the taxpayer may be interested in purchasing life insurance to pre-fund the beneficiary’s tax liability.  Life insurance proceeds are received income-tax-free by the beneficiary.  While they may be included in the owner’s estate, the estate tax exemption in 2024 is $13.61 million per individual—meaning that most will not have to worry about federal estate taxes (state inheritance and estate taxes may apply).

Those life insurance proceeds can help younger generations fund the tax bill that will apply during the period in which inherited IRA distributions must be taken.