Estate-Planning Strategies to Fill the Void Left by Stretch IRA’s Extinction

Estate-Planning Strategies to Fill the Void Left by Stretch IRA’s Extinction

Despite the widespread rumors, I am not a dinosaur.

My colleague Rebecca, her very name recalling literature’s most troublesome spirit, often has me descended from the Tyrannosaur, partly due to my bellowing roar (the lizard king likely hissed – not my style) and curiously tiny hands.

If I make the mistake of getting riled around Rebecca, she does a neat little impression of a limp-handed reptilian giant, knocking apart trees, devouring the fanciful Brontosaurus: all things I don’t do literally in my current incarnation, but must admit to liking, as they emerge from my deep evolutionary memory. Her expertise at making me look a ninny is particularly annoying when it’s deserved.

At heart, our topic today is change. This reputedly becomes difficult with age, but I think people are confusing stubbornness over comforts and a righteous belief in what our industry calls ‘best practice’ – traits that do often accompany the wizened – with ossification of imagination. The latter accusation cannot be allowed to stand, even if it requires trampling down an entire Cretaceous forest to set things straight.

We all must think creatively sometimes, no matter how it pains us, because everywhere you look, there are people dissatisfied with current arrangements and determined to shake things up. Whether a proto-rat devouring the Bronto’s eggs or a politician riled by inherited family wealth, change is ever on the wing. At last, this leads us to the extinct stretch-IRA strategy.

The stretch IRA was a worthy estate-planning tool that facilitated leaving wealth to heirs. It could provide an income top-up as needed, an asset to secure borrowings, or a long-lived, ever-growing, tax-sheltered account for future generations. It worked because the old IRA rules allowed a beneficiary to minimize the required minimum distribution (RMD) and ‘stretch’ the account’s tax-advantageous growth over a lifetime and beyond. Our wealthier clients couldn’t get enough of them.

Alas, all this is over now. Under the terms of the SECURE Act of 2019, an IRA must be cleared of its balance within ten years of being inherited. This still allows something of a ‘stretch’, but compared to the old scheme, which allowed the stretch to last over veritably geological epochs, it’s rather a comedown. Estate planners have been left in a quandary.

Change must be embraced, though, particularly by the wise old operators who rule any forest you can name. Consider my fondest hobby, photography. In the old days, a trip to the photo store for film, processing chemicals and a host of delightful accessories formed the purest joy. Opening a film box left sense memories I’m reliving now: popping the delicate perforations, reading the miniscule hieroglyphs on the temperature charts, opening the endlessly reusable canister to extract the light-grabbing magic – oh, the charms; and one hadn’t even started shooting yet.

The joy of film is largely lost today, but as a true analog veteran, I can heartily say: good riddance.

Digital is immeasurably superior: greater sensitivity, variable ISO, odorless, non-toxic processing – the list goes on. We lost a bit of romance, but artistry is enabled and thousands of dollars saved – now that’s revolutionary, not evolutionary progress.

Photographers who resisted digital – for the first decade or so, it stank – were quickly dubbed ‘dinosaurs’. Once it was ready for prime time, though, we jumped the evolutionary dead end and found ourselves in a brighter land – fewer cinematic volcanic eruptions, perhaps, but bluer skies and easier on the toxic gasses.

Evolutionary-not-revolutionary estate planners have excellent alternatives to the lost stretch IRA. First, we have the Roth IRA conversion. The pandemic may have spread turmoil, but it has also laid good foundations for spinning a standard IRA into its Roth cousin. Taxes are low now, but you won’t find anyone who believes this will last. Political changes can occur; the real-life bills for the legislative coronavirus bills will need paying; and even anti-tax forces concede the need for flexibility.

Roth IRAs work best for people who think they’ll be in a higher tax bracket when they withdraw the funds. Roth IRAs are funded post-tax, so both growth and withdrawals are tax-free. If passed to heirs, there’s a ten-year limit on taking withdrawals, but the process comes without tax pain, in clear distinction to traditional IRA accounts. If you have clients who plan to leave IRAs to heirs, talk to them about opportunities for making the conversion.

Life insurance is another alternative to the stretch IRA, but it comes at a cost: premiums are always high, perhaps brutally so, for people at and beyond retirement age. Still, for the right client, they make good sense. If the RMD from a retirement account is not needed for living expenses, the money can fund a life policy, guaranteeing a tax-free payment to the heir(s) of choice. When this strategy works, it works quite well, indeed.

There’s a clever way to replicate the stretch IRA’s features. First, create a trust with the client’s heirs named as beneficiaries. Then, use an otherwise unemployed IRA’s RMDs to fund a life policy within that trust. The tax-free death benefit will eventually fund the trust’s investments. If structured correctly, tax-deferred growth can be achieved within the trust. Payments to heirs can be structured in myriad ways, effectively mimicking the flexibility of the old stretch IRA.

The loss of the stretch IRA is lamentable, and none of these strategies is an exact replacement – we work with the tools at hand. Today, inherited wealth is commonly viewed with suspicion, so we should expect changes, however unpalatable. But with a will to evolve, we find that there’s always a way.

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