3 Stretch IRA Alternatives for Estate Planning

The elimination of the Stretch IRA as part of the Setting Every Community Up for Retirement Enhancement (Secure) Act is going to create big changes for wealth advisors, estate planners, and parents planning to leave behind savings in individual retirement accounts for 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.

The Secure Act is the most comprehensive retirement bill to pass in a decade and a half, and much of it is designed to stimulate more and better options in the workplace defined contribution market.

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.

Repak stated that existing beneficiaries of stretch IRAs will not be affected by this change in the law. However, going forward, most heirs of IRAs aside from the spouse of the benefactor will need to spend down the assets in 10 years. (There are a few exceptions, including minor children, but not grandchildren, of the benefactor, and disabled individuals.)

“Any time a change like this comes along it forces the profession to revisit the arithmetic of their planning techniques,” said Repak. “Truth be told, we’re all in the same boat and trying to evaluate it all.”

There are alternative estate planning approaches to fill the stretch void. Here are three that Repak lists:

1. Roth Conversions

“This will force people to take a hard look at Roth conversions,” said Repak.

There might be negative tax consequences for children who have been left retirement assets in traditional IRAs now that the stretch has been eliminated. If the beneficiaries are high earners, a Roth conversion might be a better option; under the traditional IRA model, the distributions would be taxed as ordinary income at a high tax rate.

It’s important to keep in mind that political changes could also determine which is the best choice. A change in administrations next fall may result in tax rates going up, which could influence whether or not it is better to convert a traditional IRA to a Roth before it is passed on.

You will also want to consider state inheritance taxes. A Roth conversion could reduce the size of the estate and reduce tax exposure.

Any alternative will have its pros and cons, of course. With a Roth conversion, there is a big tax hit on the front end.

“Just about every planning technique involves some tradeoffs,” Repak said. “But the tradeoffs can be worth it.”

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 is not a new strategy, but it is one that may gain strength now that the stretch has been eliminated.

“The strategy makes more sense under the new rules,” Repak said.

3. Charitable Remainder Trusts

IRA assets could be used to fund a charitable remainder trust, letting the benefactor establish an income stream for their children with part of the IRA assets while the remainder can go to a named charity.

The trust can grow assets tax free, but the named non-charitable beneficiaries (the kids) must pay income taxes on money they draw from this type of trust.

Repak cited two different types of trusts — a charitable remainder annuity trust, which distributes a fixed annual annuity and does not allow continued contributions, and a charitable remainder unitrust, which distributes a fixed percentage of the initial assets and allows continued contributions.

“I think this is one of the most interesting options, but it’s important to bear in mind that this works best for a family that already has philanthropic intentions,” Repak said.

For help determining which stretch IRA alternative is best for your estate plan, contact us at Wilson and Wilson Estate Planning and Elder Law, LLC, 708-482-7090 or wwilson@wilsonwilsonllc.com