Three replacements for Stretch IRAs
The elimination of the Stretch IRA is a game changer, especially for parents who were considering bequeathing savings in IRAs to their kids.
“For a lot of people, the bulk of their wealth has been established in their IRAs,” said Michael Repak, vice president and senior estate planner with Janney Montgomery Scott. “This law, even though it didn’t get the publicity of the Tax Cuts and Jobs Act, will have an equal impact on estate planning.”
The bill will add $428 million to the federal budget over 10 years. Of its $16.2 billion in revenue provisions, $15.7 billion is accounted for by elimination of the stretch IRA.
Existing beneficiaries of stretch IRAs will not be affected by the change in the law, noted Repak. But going forward, most heirs of IRAs other than the spouse of the benefactor — with a few exceptions — will have to spend down the assets in 10 years.
Alternative estate planning approaches will emerge to fill the stretch void. Here are three that Repak thinks will garner attention.
1. Roth Conversions
Traditional IRA owners who had intended to leave their retirement assets to their children may be passing on negative tax consequences now that the stretch has been eliminated.
If the beneficiaries are high earners, a Roth conversion may make sense; under the traditional IRA model, the distributions would be taxed as ordinary income at a high tax rate.
There are also political implications in the short and near term. A change in administrations next fall may result in tax rates going up. That, too, could influence whether to convert a traditional IRA to a Roth before it is passed on.
Another consideration is state inheritance taxes. A Roth conversion could reduce the size of the estate and reduce tax exposure.
2. Life Insurance
The death benefit of a life insurance policy is not included as the beneficiary’s income.
Using distributions from an IRA to pay for the policy — assuming the benefactor is insurable — is not a new strategy, but one that may take on new vitality with the elimination of the stretch.
3. Charitable Remainder Trusts
IRA assets could be used to fund a charitable remainder trust, which allows the benefactor to establish an income stream for their children with part of the IRA assets, with the remainder going to a named charity.
The trust can grow assets tax free, but the named non-charitable beneficiaries (the kids) do pay income taxes on money they draw from the CRT.
Repak cited two different types of trusts — a charitable remainder annuity trust, and a charitable remainder unitrust. The former distributes a fixed annual annuity and does not allow continued contributions; the latter distributes a fixed percentage of the initial assets and allows continued contributions.