The so-called Stretch IRA may become a thing of the past if lawmakers get their way. So, what exactly is a Stretch IRA you ask? In basic terms, a Stretch IRA is the ability to name your child or grandchild the beneficiary of your IRA (traditional or Roth) who can then “stretch” out withdrawals over his or her projected lifespan. Therefore, they’ll add decades of tax-deferred or tax-free growth. Further, it’s become a big reason for people to convert to a Roth IRA since it will allow tax-free growth for years to come if you bequeath it to a young person.
Lawmakers are trying to close up this loophole by forcing non-spousal heirs to take distributions of the IRA within five years. Further, if it’s a traditional IRA, will owe the taxes due in that same time frame. If the heir is disabled, he or she may still stretch out the account and if the heir is a minor, he or she would have until age 26 to distribute the account. Spouses will still have great flexibility with the account including rolling it over into his or her own name.
“Millionaires, billionaires can pass on millions in their IRAs to their heirs without paying taxes for years, if not decades. That was never what IRAs were for. That is a loophole. It has to be closed,” Sen. Tom Harkin argued recently.
So what can you do now to prepare yourself for the inevitable?
First off, check your beneficiary designations. Your best bet, if you’re married, is to name your spouse as your primary beneficiary. If you have kids, you should name them as your secondary beneficiary. Therefore, in the event of your passing, your spouse can decide, based on his or her financial situation and inherited IRA rules, to keep the IRA or disclaim it so it will go to your child(ren).
Next, if you’re planning on performing a Roth conversion, figure out if it makes sense to do so under possible new rules of the Stretch IRA. Don’t assume your heirs can continue to receive a tax break and convert only for this reason. The main reason to convert is to pay taxes now at a lower tax rate than you might be in the future.
Proper asset allocation should be a major factor as well. “If you hold stocks, funds and other assets such as real estate in regular (non-retirement) accounts, they get a step-up in basis to their current market value at your death—-meaning that your heirs can sell them immediately without paying capital gains taxes. There’s no step up for IRA assets and anything heirs take from a traditional IRA is taxed at high ordinary income rates. But if Obama, Senate Democrats and the ABA Tax Section have their way, your heirs won’t even be able to stretch out that tax hit over decades,” says Forbes.com staffer Janet Novack.
Lastly, figure out any charitable bequests you plan to make upon your death. It’s always best to leave your pre-tax assets to a non-profit if you wish. Your heirs have to pay ordinary tax on withdrawals from a traditional, pre-tax IRA. If they cannot spread out those withdrawals, they’re tax bracket will usually bump up meaning they will owe more on taxes. Charities are exempt from the tax when they cash in the IRA. You can then leave a tax-free Roth to your heirs.
This could take years or never even come to fruition, but it’s best to play it safe when it comes to your retirement. If you have any questions about the Stretch IRA or anything else IRA-related, contact the tax professionals at the IRA Financial Group today at 800.472.0646! Be sure to follow us on Twitter @Bergman401k!