The IRS has always taken the position that your Retirement Accounts – IRA, 401(K), 403(B), etc. are to be used to assist you with your retirement expenses and used during your lifetime. Therefore those accounts are to have the money pulled out of them and the Deferred Income Taxes paid during your lifetime. The IRS opposed the idea that your Retirement Account would be passed on to your loved ones upon your death and that the advantages of the Deferred Income Tax Growth in those accounts would pass on to your children.
(It has always been an accepted exception that your Retirement Account could be left to your surviving spouse and that it magically “Rolled Over” to your surviving spouse with no real negative consequence. This exception only applies to the surviving spouse.)
Prior to the enactment of the “SECURE Act” on January 1, 2020, one could bequeath their Retirement Account to their child (for example) and that child enjoyed an even better deferred Income Tax Free Growth than you did. (We’ll show you how below.)
Your IRA Withdrawals:
In April of the year you turn 70 & ½ years old you are required by law to start withdrawing money from your Retirement Account and the IRS can start taxing that Tax Deferred Income withdrawn from that Retirement Account.
Your Account Treatment:
The amount you have to withdraw is determined by an IRS Life Expectancy Table that sets out the percentage of the value of the Account that you must withdraw. They use the December 31 value of the Account the year before to apply to that percentage to determine the dollar amount that must be withdrawn. Many people don’t want to pull out the Retirement Account money as they don’t need it to live and the added income will likely push them into a higher income tax bracket for the year.
The older you are, the more the Retirement Account money must be withdrawn as statistically your life expectancy shortens.
Your Child’s Withdrawals:
(When I speak of “Inherited IRAs” “IRA Stretches”, “Stretch IRA”, or “Withdrawals”, I am referring to Retirement Account Stretches or Withdrawals. Although many people roll their Company Retirement Accounts into Self Directed IRAs for flexibility purposes.)
When your child inherits the “Stretch IRA” from you by being the named “Death Beneficiary“ of that Account, or the Beneficiary of a Trust named as the Death Beneficiary of the Account, the “Measuring Life” of that account, (your child) has a much longer statistical life expectancy than you. That is calculated by using that same IRS Life Expectancy Chart you use. As your child is a generation younger than you, their life expectancy is much longer than yours.
What Does That Mean?
Your Adult Child has a much lower percentage number that must be withdrawn from the Retirement Account each year. Therefore your Adult Child received an even greater Deferred Income Tax Free Growth than you did.
This is referred to as “Stretching” that IRA Tax Deferred Growth over time by the next generation down from the Retirement Account Owner. This was a powerful Investment Vehicle for the Adult Child receiving the “Inherited IRA” “Stretched IRA”, or “Stretch IRA”.
So What Changed?
The IRS finally got their way!
Except for the exception (and a few others) of the surviving Spouse inheriting their dead spouses IRA and magically “Rolling Over” that IRA as if it originally belonged to them and a few other narrow exceptions, the “Stretch IRA” died on January 1, 2020.
From January 1, 2020 on, the (non-spouse) person inheriting that IRA generally can no longer withdraw the money slowly over time because of their much statistically longer life expectancy and enjoy that continued Income Tax Deferred Growth.
So Now What?
The IRS won in that now you must withdraw all of that Retirement Account Money within ten (10) years!
You can take out a percentage of that Account over the ten (10) year period or take it out in year Ten (10). Regardless of how it is withdrawn it has to be withdrawn in ten (10) years. It is then income taxed by the Dark Empire, I mean IRS.
So … the “Stretched IRA” or “Stretch IRA” left to your younger generations no longer receives the excellent Tax Deferred Growth of the “Stretch IRA”.
So … as the money from the “Stretch IRA” is taxed when it leaves the IRA the Tax Deferred Growth is lost. It is especially evident if you calculate the Tax Deferred Growth over decades. Therefore those receiving “Stretch IRAs” can no longer “stretch” the smaller withdraws over decades and enjoy decades of Tax Deferred Growth. They must withdraw all monies in the IRA within ten (10) years.
So … the IRS, the Dark Empire, wins what they have always wanted on IRAs. That the IRA dies not long after the IRA owner dies.
SO WHAT CAN WE DO?
At the Law Firm of Steven Andrew Jackson, Attorney and Counsellor at Law, we have helped hundreds of families protect themselves and their loved ones, avoid Estate Taxes and Probate Costs, and keep their Estate Plans current with the law through The Customized Protective Estate Planning Solution™.