Perspective Matters
The Stretch IRA has been an essential component of numerous individuals' financial and estate strategies for many years. It has enabled beneficiaries who inherit an IRA from someone other than their spouse to postpone income taxes on a portion of the IRA, effectively "stretching" the withdrawals throughout their lifetime. While a beneficiary always has the option to withdraw more than the mandated annual distribution, the Stretch IRA has offered remarkable flexibility for all involved.
The spouse of the deceased IRA owner has always had the choice to "rollover" the IRA into their own account, allowing them to follow the same rules that apply to IRA owners. Before the introduction of the Stretch IRA, non-spouse beneficiaries were required to fully withdraw the IRA within five years. The Stretch IRA offered an additional option for both spouses and non-spouse beneficiaries.
The Stretch IRA allowed a spouse beneficiary to access the account before reaching 59 ½ without incurring the 10% early withdrawal penalty. Non-Spouse beneficiaries could use a Stretch IRA instead of being required to empty the IRA within five years, allowing them to deplete the account and settle any income tax obligations over their own lifetime.
Parents were able to utilize the Stretch IRA in conjunction with certain trusts to ensure a steady lifetime income for their children, while safeguarding the account from hasty spending choices and complicated divorces. By extending the IRA distributions throughout the beneficiary's life—which could span decades after the IRA owner's passing—tax-deferred growth could persist. A well-managed portfolio often generates returns that exceed the mandatory distribution for most adults. This strategy enabled the account's value to continue growing tax-deferred, could allow for annual increases in withdrawals at a relatively predictable minimum rate, and facilitated the efficient transfer of wealth to the next generation.
THEN ALONG CAME THE SECURE ACT AND THE PARTY WAS OVER
Before 2020, any Designated Beneficiary (essentially any individual) had the option to establish an Inherited IRA and enjoy the various benefits mentioned earlier. In contrast, a Non-Designated Beneficiary (which refers to beneficiaries that are not individual persons, such as charities or estates) was obligated to withdraw the entire IRA within five years, much to the IRS's delight (unless the beneficiary happened to be a charity).
The SECURE Act expanded the classes of beneficiaries to three: Eligible Designated Beneficiaries (EDBs), Non-Eligible Designated Beneficiaries (NEDBs) and Non-Designated Beneficiaries (NDBs).
No modifications were made for Non-Designated Beneficiaries, in terms of either the definition or the options available for taking distributions.
Designated Beneficiaries are categorized into Eligible and Non-Eligible groups, which determines who can continue to utilize the Stretch IRA. A Designated Beneficiary who does not qualify as an Eligible Designated Beneficiary (EDB) is classified as a Non-Eligible Designated Beneficiary (NEDB) and must adhere to the “10-year rule.”
CONFUSED YET?
Please hang in there a bit longer, and things may become clearer soon.
There are five categories of EDBs (Eligible Designated Beneficiaries), individuals who can continue to benefit from the Stretch IRA, allowing them to take IRA distributions based on their life expectancy:
Surviving Spouses
Minor children of the IRA owner (but NOT grandchildren) AND only until age 21
Disabled individuals (under the strict IRS rules)
Chronically ill individuals
Individuals who are older than the IRA owner or not more than 10 years younger than the IRA owner
Trusts established exclusively for the benefit of an EDB should also be recognized as an EDB.
It is important to mention that any Designated Beneficiary who inherited prior to 2020 is grandfathered under the old rules.
TWO MORE IMPORTANT THINGS TO NOTE
EDB status is determined on the date of the IRA owner’s death and cannot be changed.
Once an EDB no longer qualifies as an EDB (including by dying) the 10-year rule is then applied to them, or to their beneficiaries (also known as “successor beneficiaries.”)
So, a minor child is an EDB, and when they turn 21 the 10-year rule kicks in, and they have ten years to empty the account.
TO RECAP
People are generally going to be either EDBs or NEDBs
Charities or other “non-persons” are generally going to be NDBs – and none of their rules changed with the SECURE Act
EDBs can still use the Stretch IRA, but few people qualify as EDBs
NEDBs must withdraw all of the IRA they have inherited within ten years
There’s another important aspect to consider. A defining feature of Stretch IRAs is that they require an annual distribution. Therefore, an Eligible Designated Beneficiary (EDB) must withdraw funds each year, calculated according to their life expectancy. But what about a Non-Eligible Designated Beneficiary (NEDB)? Do they need to take a distribution every year, or can they wait until the tenth year to make one substantial withdrawal? The answer varies based on specific circumstances.
I KNOW YOU WERE HOPING FOR A SIMPLE ANSWER BUT I DO HAVE ONE SIMPLE RULE YOU CAN FOLLOW
If the IRA has already had any kind of required distribution “turned on” they can’t be “turned off.”
If the original IRA owner has reached the age at which they must begin taking their Required Minimum Distributions (RMDs), the Non-Eligible Designated Beneficiary (NEDB) must also continue to take annual distributions. The amount of these distributions will be determined by the NEDB's age rather than the IRA owner's age. Additionally, the NEDB is allowed to withdraw more than the minimum required, and many do so as part of their tax strategy. It's crucial to note that certain NEDBs are required to take annual distributions during years 1-9, while others may not have that obligation.
In case this isn't already confusing enough, remember that an Eligible Designated Beneficiary (EDB) can utilize the Stretch IRA as long as they still meet the criteria for EDB status. Since an EDB benefits from the Stretch IRA, and the IRS mandates annual distributions, an EDB who transitions to a Non-Eligible Designated Beneficiary (NEDB) because they no longer qualify as an EDB must also keep taking these annual distributions. A straightforward example of this scenario is a minor child beneficiary who turns 21. While the minor child is considered an EDB, upon reaching the age of 21, they become an NEDB and are required to continue making annual withdrawals.
There are additional factors that anyone who owns or inherits an IRA should keep in mind, but I’ll save those for another time. I hope I've provided you with valuable insights and highlighted that many considerations come into play when addressing the question, "What is the best option?" for a beneficiary to take withdrawals from an IRA."
Before diving into the complex world of IRAs, consider consulting a professional. A Certified Financial Planner® can guide you in exploring the best planning options tailored to your needs, and a member of Ed Slott’s Elite IRA Advisor group is well-versed in the intricacies of IRAs. The journey to financial independence comes with its own challenges, so seek the assistance you need to focus on living your best life.
Neither Prism Planning and Solutions Group nor Insight Advisors provide tax advice, and nothing in this communication should be treated as such. This communication should not be interpreted as a recommendation for a specific investment or tax-
planning strategy. We are providing this material for informational purposes only. We have made every attempt to verify that information contained in this communication is accurate as of the date published but make no warranties. Before making any decisions related to your own tax and/or investment situation you should consult the appropriate professionals.
Certified Financial Planner Board of Standards, Inc. (CFP Board) owns the certification marks CFP®, CERTIFIED FINANCIAL PLANNER™, and CFP® (with plaque design) in the United States, which it authorizes use of by individuals who successfully complete CFP Board’s initial and ongoing certification requirements.