Stretch IRAs still exist for some beneficiaries

Although the SECURE Act eliminated stretch IRAs for most beneficiaries, replacing them with the 10-year post-death payout rule, some beneficiaries can still use a stretch IRA.

The so called “stretch IRA” allows designated beneficiaries to extend required minimum distributions and the tax deferral over their life expectancy based on their age in the year after death. Designated beneficiaries are individual beneficiaries named on the individual retirement account or plan beneficiary form — not an estate, charity or nonqualifying trust.

Congress didn’t like the idea that beneficiaries could extend payouts for years or even decades after they inherit, so the SECURE Act eliminated the stretch IRA for most non-spouse beneficiaries and replaced it with a 10-year post-death payout rule.

But some beneficiaries can still use the stretch IRA.

[More: Can a trust transfer an IRA to a trust beneficiary?]

EDBs

Eligible designated beneficiaries enjoy special treatment under the SECURE Act and can still use the stretch IRA until they either no longer qualify as an EDB or die.

The SECURE Act exempts these beneficiaries from the 10-year rule. However, if the account owner dies before the required beginning date, an EDB can elect the 10-year rule, but then the stretch would be lost. If they elect the 10-year rule, no RMDs would be required during the 10-year term, since death was before the RMD, but the entire balance in the inherited IRA must still be withdrawn by the end of the 10^th year after death.

EDBs must be designated beneficiaries, so make sure they are individuals named on the IRA or plan beneficiary form.

5 CLASSES OF EDBs

1. Surviving spouses
2. Minor children of the account owner, until age 21 — but not grandchildren
3. Disabled individuals — under the strict IRS rules
4. Chronically ill individuals
5. Individuals not more than 10 years younger, or older, than the IRA owner

EDBs also include any designated beneficiary (including qualifying trusts) who inherited before 2020. These beneficiaries are grandfathered under the pre-2020 stretch IRA rules. In addition, conduit trusts for the sole benefit of these EDBs can qualify as an EDB under the IRS proposed regulations.

EDB status is determined as of the date of the account owner’s death and cannot be changed.

Example 1

IRA owner dies in 2022 at age 75 (after the RBD) and the beneficiary is his 70-year-old sister. The sister is an EDB because she’s not more than 10 years younger than him, so she can stretch the inherited IRA over her life expectancy based on her age in 2023 (the year after death). The Single Life Expectancy Table gives her an 18.0-year lifetime payout, based on age 71 (her age in the year after his death). She can continue that payout schedule, reducing the 18.0-year factor by one for each year.

But when the sister dies, her beneficiary (the successor beneficiary) will be subject to the 10-year rule and will have to empty the inherited IRA by the end of the 10^th year after the original beneficiary’s death – by December 31, 2032.

In addition, according to the IRS 2022 proposed RMD regulations, RMDs would be required for years one through nine of the 10-year term, since the original beneficiary (the sister) had already begun RMDs

That’s because of the IRS’s interpretation of the so-called “at least as rapidly,” or ALAR, rule, which says that once RMDs have begun, they can’t be turned off. In this case, the sister as an EDB had already begun taking stretch IRA RMDs, so the successor beneficiary must continue them for years one through nine, and the remaining balance in the inherited IRA must be withdrawn by the end of year 10.

The IRS regulations may go even further than this. Under the IRS’s apparent interpretation of the SECURE Act RMD rules, even if the IRA owner died before the RBD, the successor beneficiary will still be subject to RMDs for years one through nine of the 10-year term. Because the sister had already begun RMDs as an EDB, under the ALAR rule the successor beneficiary cannot turn them off. (The IRS may need to clarify this.)

CONDUIT TRUST

When an IRA owner designates a conduit trust as IRA beneficiary and the trust beneficiary is an EDB, the IRS proposed RMD regulations allow those trusts to use the stretch IRA. A conduit IRA trust requires RMDs paid to the trust to be immediately paid out to the trust beneficiary, so no funds are retained in the trust. If the trust beneficiary is an EDB, then the stretch IRA will be allowed.

Example 2

The IRA owner names a conduit trust for her minor child, her 15-year-old daughter. Assuming the trust qualifies as a “see-through” trust under IRS regulations, the inherited IRA will qualify for the stretch IRA based on the child’s life expectancy.

However, the minor child’s status as an EDB ends at age 21, regardless of state law. After that, the 10-year rule will apply, including RMDs under the ALAR rule for years one through nine of the 10-year term. Under the IRS RMD regulations, this would apparently be the outcome whether the IRA owner died before or after the RBD, because the child had already begun stretch IRA RMDs as an EDB.

At the end of the 10-year term, the remaining balance of the inherited IRA must be paid out to the trust and then from the trust to the trust beneficiary (the child in this case).

That might not be the best plan since a still relatively young child could have access to large sums. A better option might be an accumulation (discretionary) trust where funds can be retained in trust, but then the trust won’t usually qualify as an EDB because the inherited funds may not all be paid out to the trust beneficiary. Plus, funds retained in the trust for further protection could be subject to high trust taxes, unless this was a Roth IRA.

PRE-SECURE ACT BENEFICIARIES

The SECURE Act is effective for inheritances in 2020 or later, but many beneficiaries inherited before then, and they can keep their stretch IRAs.

Example 3

Grandpa died in 2019 (before the SECURE Act) and left his IRA to his 10-year-old grandchild. That grandchild can continue her stretch IRA schedule for more than 70 years because she inherited before 2020. Under the SECURE Act, a designated beneficiary who inherits before 2020 is treated as an EDB (eligible designated beneficiary) and will not be subject to the 10-year rule. However, when this beneficiary dies, the successor beneficiary (the beneficiary’s beneficiary) will be subject to the 10-year rule and will have to empty the inherited IRA by the end of the 10^th year after the original beneficiary’s (the grandchild’s) death.

But once again, under the ALAR rule, the successor beneficiary would also be subject to RMDs for years one through nine after the death of the original beneficiary. This is apparently the case even if the original IRA owner died before his RBD.

It’s not as readily available anymore, but the stretch IRA is still around for some beneficiaries, but only until they no longer qualify or die. Then it gets even more complicated.

For more information on Ed Slott and Ed Slott’s 2-Day IRA Workshop, please visit www.IRAhelp.com