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Tax Impact of Stretch IRA Phase Out for Non-Spousal Beneficiaries

Posted on: January 24th, 2017
end of stretch IRAThe Senate Finance Committee recently voted unanimously to eliminate stretch IRAs (Individual Retirement Accounts) for non-spousal beneficiaries. The pending legislation imposes a five-year payout deadline for accounts left to non-spousal beneficiaries, with an exemption of $450,000 per account holder. 

While elimination of the stretch IRA has been a recurrent item among lawmakers, a few factors suggest the stretch IRA will ultimately phase out in 2017. Separate tax reform bills, forecasts by financial analysts, and experts recently cited in Financial Advisor consistently support the forthcoming end of the stretch IRA.

The phase out is part of the Retirement Enhancement Savings Act (RESA). The Act includes additional provisions, many of which encourage contributions to retirement savings. Some of the provisions offer a credit to employers for automatically enrolling employees in retirement plans, repeal of the maximum age for traditional IRA contributions, an increase in penalties for failing to file retirement plan returns, among many other changes.

Stretching inherited IRA distributions over one’s lifetime is currently possible in some situations for non-spousal beneficiaries. While a surviving spouse can elect to rollover their deceased spouse’s retirement savings into their own, via a spousal IRA rollover, that option is not available to non-spouses. Non-spousal beneficiaries generally opt to stretch distributions from inherited IRAs over their lifetime to minimize the tax impact. If RESA passes in 2017 as it is expected to, asset preservation strategies utilizing current traditional IRA funds, such as purchasing life insurance or converting to a Roth IRA, may become more popular.

Individuals who currently have a stretch IRA or inherit an IRA should review options with a tax attorney. Account owners should consult with their tax attorney or financial advisors to determine how best to structure asset transfers to help minimize tax implications. 

A few important items to help guide discussions:
Inherited IRA Ruling. A Private Letter Ruling issued in 2016 shows clear distinction between federal and state laws pertaining to inherited IRAs and non-spousal rollovers.

Tax Preparation for Inherited IRAs. A few opportunities to minimize tax on inherited retirement accounts.

Reasons to Not Name Living Trust as IRA Beneficiary. Understand the effect this planning method has on probate, which can affect required minimum distributions, creditor protections, and other matters.
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