“New legislation that aims to give workers greater opportunities to save for retirement, may put the kibosh on a strategy for passing large individual retirement accounts to heirs.”
Congress’ House Ways and Means Committee has passed a bill known as the Secure Act. This bill would require employers with a 401(k) plan to allow long-term part-time workers to participate. It would also create a $500 tax credit for small companies that start retirement plans with automatic enrollment.
CNBC reports, in its recent article “Congress may gut the 'stretch IRA' that wealthy people love,” that the bill includes a provision that would force non-spouse beneficiaries to draw down inherited retirement accounts within 10 years of the original owner's death.
This provision could discourage the use of a "stretch IRA." This strategy allows younger heirs to take required minimum distributions (RMDs) from the inherited account, based on their own much longer life expectancy. They receive the advantage of "stretching" the IRA's tax-deferred growth over many years, while taking smaller RMDs.
If you inherit an IRA from someone who is not your spouse, you're now generally required to begin taking RMDs based on your life expectancy by December 31, after the year the original account owner died. However, the House version of the bill would force a distribution of the account's value within 10 years. The Senate version would distribute the account in five years, if the beneficiary isn’t a spouse and if the account value exceeds $400,000 as of the date of death.
Both versions of the legislation have an exception, if the beneficiary is the surviving spouse, a disabled or chronically ill person, an individual who is no more than 10 years younger than the account owner, or the minor child of the account owner.
The stretch IRA is most attractive to young heirs of larger accounts. They have years of tax-deferred growth ahead of them, and they must only take a small distribution each year. However, an accelerated distribution over a much shorter period of time, would mean a big tax liability.
There are a few alternative strategies that IRA owners might look into to minimize taxes, while passing on the account to a non-spouse heir, if the bill passes. A charitable remainder trust lets investors leave assets to a charitable organization and to a beneficiary. The beneficiary would get income from the assets for a specified time, and then the charity would get whatever’s left. You’d have to name the trust as the beneficiary of the IRA, which can cause tax issues, if done incorrectly. Be sure to work with an estate planning attorney, if you're considering this.
With life insurance, you could get more money tax-free without any RMD or complexity, and just bypass the whole system. The death benefit of a life insurance policy is typically excluded from the recipient's gross income, and your premium dollar also goes further.
Reference: CNBC (April 11, 2019) “Congress may gut the 'stretch IRA' that wealthy people love”