What will replace the stretch IRA?

In the wake of the SECURE Act, most people who inherit IRAs will be subject to a 10-year rule

Yes, the stretch IRA is dead. It has been replaced by a 10-year post-death payout rule, but how does that work? Who is subject to it? When does it start and when does it end?

Except for spouses, most people who inherit individual retirement accounts will be subject to a 10-year payout rule. Under that rule, all the assets in the inherited IRA or Roth IRA must be withdrawn by the beneficiary by the end of the 10th year after the account holder’s death.

There are no annual required minimum distributions during the 10 years, leaving that period open for withdrawals that the beneficiary can plan out according to his or her personal tax situation, as long as the account is emptied by the end of the 10th year.

Example

Joe has an IRA and dies in 2020. His beneficiary is Bill, his 40-year-old son. Bill does not get the stretch IRA, as he would have if he had inherited it in 2019 or earlier. Instead, he is subject to the 10-year rule. Bill can withdraw any amounts he wishes in the first nine years, but he must withdraw the entire remaining balance by the end of the 10th^t year after his father’s death, which in this example would be by Dec. 31, 2030.

Some beneficiaries still qualify for the stretch IRA, the same as under the old rules. These beneficiaries are now called “eligible designated beneficiaries,” or EDBs. This group includes surviving spouses, minor children up until they reach their majority – but not grandchildren, disabled or chronically ill individuals, or those who are not more than 10 years younger than the IRA owner. Anyone who inherited before 2020 is automatically grandfathered into this group.

The 10-year flip

Even for EDBs though, the stretch will end and flip to the 10-year rule. Generally, the stretch IRA will end at the death of the EDB, or, for minor children, when they reach the age of majority (which is 18 in most states) or, if they are still in school, when they reach age 26.

10-year flip for minors

If a minor inherits an IRA at age 11 in 2020, he can begin the stretch by taking RMDs based on the 70-year payout amount. These RMDs must be taken each year, the same as under the old rules. Once the minor reaches age 18, the 10-year rule kicks in. The minor will turn age 18 in 2027 and that will be the last year for his stretch IRA. In 2028, he flips to the 10-year rule and the account must be emptied by the end of 2037, the 10th year after the year he reached majority. He can withdraw whatever he wishes over the next 10 years, but the account must be emptied by the end of 2037.

10-year flip for pre-2020 grandfathered beneficiaries

Beneficiaries who inherited before 2020 can continue the stretch IRA under the old rules, but when they die, their stretch period flips to the 10-year rule for their beneficiary — the successor beneficiary. All successor beneficiaries who inherit in 2020, or later, are subject to the 10-year rule. This is true even if they otherwise would qualify as an EDB, for example, as a disabled person.

If the original beneficiary was an EDB, after the death of the EDB, the identities of the EDB and the successor beneficiary don’t matter. The payout period flips to the 10-year rule after the EDB dies.

IRA trusts

Trusts that are IRA beneficiaries also will be subject to the 10-year rule unless they are properly set up for the sole benefit of an EDB. The entire inherited IRA balance will have to be paid out to the trust by the end of the 10th year, but the funds do not necessarily have to be paid out from the trust to the trust beneficiaries. That would depend on the terms of the IRA trust. Most trusts will need an overhaul due to the major changes under the SECURE Act. Advisers should contact clients with such trusts immediately.

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