Introduction
A stretch IRA is an Individual Retirement Account (IRA) that allows the account holder to name a second-generation beneficiary, extending the IRA's useful life span. Through this method, the IRA can be passed down through families while still enjoying tax-deferred growth for many years after the original account holder has passed away. Instead of referring to a specific form of IRA, the term "stretch" refers to a financial approach that allows individuals to enjoy the benefits of a Stretch IRA over a more extended period.
How Did Stretch IRAs Work?
A "stretch IRA" was not a distinct IRA variant. Instead, it's a method of maximizing the tax benefits of individual retirement accounts (IRAs), mainly traditional IRAs. By elongating an IRA, you can let your money grow tax-free for years or even decades. An extremely young recipient may receive payments for many years to come. A more significant portion of contributions could be left in the IRA for future generations, thereby "extending" the account over time. Income tax on required minimum distributions from a traditional IRA was also reduced.
Eligibility
An inherited stretch IRA might be rolled into a new retirement plan for any individual beneficiary, including a child, grandchild, niece, nephew, or friend. There was a blanket exclusion of trusts and philanthropic organizations because they do not have expiration dates.
Required Minimum Distributions
Specific retirement plans include annual withdrawal stipulations known as required minimum distributions. That's because your contributions to your Traditional IRA will reduce your taxable income. However, the Internal Revenue Service is looking to make some money off these accounts, so the money taken out is subject to taxation at the owner's ordinary income rates. If the owner's 70th birthday falls on or after July 1, 2019, the owner is exempt from mandatory withdrawals until age 72 if retired, thanks to the SECURE Act. The IRS imposes severe penalties on account holders who fail to withdraw their cash by the requisite age. Roth IRAs are exempt from these stipulations.
Required Minimum Distributions
Specific retirement plans have annual withdrawal quotas that must be met in the form of mandated minimum distributions. Because of a provision in the Internal Revenue Code, tax breaks are available for IRA contributions to a Traditional IRA. The Internal Revenue Service (IRS) has to generate revenue from these accounts, so the money taken out is subject to taxation at the account holder's average income rate. If the owner turns 70 on or after July 1, 2019, they are exempt from the SECURE Act's withdrawal requirements for retirees until they are 72.
When Beneficiaries Have To Begin Taking RMDs
In most cases before the SECURE Act of 2019, a beneficiary of an inherited IRA might choose between two different paths. Within five years of the account holder's death, the beneficiary could take out the total balance, or within one year, they could start taking RMDs based on their life expectancy. Required distributions and annual taxable income would have been lower for the recipient if their life expectancy was significantly higher than that of the owner.
As a bonus, the account balance may have grown tax-free. Required minimum payouts did not need to be spread out over the beneficiary's expected lifespan if the beneficiary qualified for this option. They could have cashed out their inherited IRA whenever they wanted, but doing so would have included the total amount as income in the year of withdrawal. Taking merely the minimum annual payout is preferable from a tax perspective if the beneficiary does not need the money immediately.
Stretch IRAs: Who Used Them
Wealthier retirees are confident that their spouse will have sufficient retirement savings. They typically use a stretch IRA to ensure that their children and grandchildren inherit a substantial portion of their estate. Because their required minimum distribution (RMD) taxes will be low, the rest of their IRA money will increase tax-free. When combined with Roth IRAs, stretch IRAs proved to be extremely helpful. RMDs were obligatory for beneficiaries of inherited Roth IRAs but not for the Roth IRA's original owner. Unlike traditional IRAs, where withdrawals are taxed as regular income, Roth IRA distributions are not subject to taxation.
Conclusion
Notably, the Stretch IRA-killing SECURE Act feature only applies to accounts whose owners pass away after December 31, 2019. According to the prior policy, inherited reports will continue to be distributed to beneficiaries throughout their expected lifespan. Anyone with an inherited IRA or who expects to receive one in the future should consult a financial or tax professional to ensure they are by the new regulations.
