The New Stretch IRA For Inheritance Planning
One topic of value that has come about this past year from recent tax law changes, primarily from the SECURE Act of 2019, was the amended rules on inheriting a retirement account. For years, non-Spouse beneficiaries (children) have been able to take advantage of rolling over a deceased parent’s IRA into their own Beneficiary or Inherited IRA. This provided them a way to take annual Required Minimum Distributions (RMDs) over the beneficiary’s life expectancy, therefore spreading out paying taxes on these funds sometimes for decades. It became known as the “Stretch IRA” by stretching out distributions and taxes.
One of the few disadvantages that came about last year from this Act was the elimination of this provision, now requiring any IRA funds that are inherited to be spent down within 10 years from the inheritance. So, you can still “Stretch” for up to 10 years, but by the end of the 10th year, it has to be fully liquidated. This is a creative way to generate more tax revenue, without technically raising taxes.
Why should this be of concern? In many cases it may not be, but if you’re like many savers we meet with, the majority of your or your parent’s retirement savings has been in the form of the 401k’s that eventually get rolled over into IRAs. At what age are most people likely to be when their parent’s pass? Typically, between ages 50-70, or their highest earning years. Now, if you inherit say a $500k IRA and had to distribute it over 10 years, it is adding those distributions to your taxable income each year and could bump you into a higher tax bracket, which are scheduled to increase in 2026.
One solution we’ve used for future planning surprisingly is permanent life insurance. Since life insurance death benefit proceeds are tax-free (up to the high estate tax limit), we’ve found certain policies could be funded from current unused RMDs or current low interest savings to be inherited and continue to be stretched out. An example of this may be someone in their 60s or early 70s funding a policy with $50k annually from an IRA to purchase a $2 or $2.5Million insurance policy to leave behind. If they believe there will be IRA funds left to their children regardless of their spending needs, they can pay some of the taxes now at an assumed lower rate, leave it to their children without affecting their taxes, and they can decide how long to stretch out the distributions. Even at age 90, we are seeing the taxable equivalent yield typically between 5-8%, depending on insurable health ratings.
While this may not be an exciting topic to discuss, we’ve seen it become a popular strategy to help shield against rising tax rates and retain more flexibility planning a future estate. If you’ve saved a lot of your retirement in IRAs or 401ks, or are worried about a parent’s IRA/401k inheritance, this is a simple solution that may help make those funds last longer and potentially less of your hard earned savings to Uncle Sam.
As always, if you’d like a complimentary second opinion for your financial planning, please reach out to Douglas Marion with Advanced Wealth Strategies. Feel free to call or text (704) 765-3653 or email Douglas@PlanWithAWS.com. Their local office is conveniently located at 19520 W. Catawba Ave, Suite 313 in Cornelius. As fiduciaries, their independent firm will put your best interests as priority.
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