The Requirements for a Trust to Stretch in an IRA

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A "stretch IRA" gets its nickname literally. It's an inherited individual retirement account whose beneficiary is eligible to "stretch" the required minimum distributions over a longer period of time, based on their own life expectancy. Their life expectancy is determined by the applicable IRS life expectancy table. They don't have to use the decedent's life expectancy, which in most cases would be significantly shorter.

The Setting Every Community Up for Retirement Enhancement (SECURE) Act is an expansive retirement bill that was signed into law on December 20, 2019, eliminated the “stretch IRA,” which allowed non-spousal beneficiaries to withdraw assets of inherited accounts over their lifetimes. Now, those who inherited an IRA since the beginning of 2020 and thereafter have 10 years to withdraw the assets—however, or whenever they’d like. Spouses and disabled beneficiaries are among the exceptions to the rule.

Who Is Eligible

Any individual beneficiary, such as a child, grandchild, niece, nephew, or even a friend, is eligible to stretch an inherited IRA. Charitable organizations are not eligible because they do not have life expectancies.

Required Minimum Distributions

A required minimum distribution often called an RMD, is an amount that must be withdrawn from certain retirement plans each year according to tax law. The owner of the account cannot leave the account intact indefinitely, allowing it to continue to grow tax-free.

The Internal Revenue Code provides that contributions made to a Traditional IRA are tax-deductible. But the IRS wants some revenue out of these accounts, so withdrawals are taxed at the owner's regular income rates. Due to changes made by the SECURE Act, if the owner's 70th birthday is July 1, 2019, or later, they do not have to take withdrawals until they reach age 72 if retired.

However, if they do not take them by the required age, the IRS imposes some stiff penalties. These requirements do not apply to Roth IRAs.

When Beneficiaries Have to Begin Taking RMDs 

Prior to the SECURE Act of 2019, the beneficiary of an inherited IRAs generally had two options. They could withdraw the entire account within five years of the owner's death, or begin taking RMDs based on their own life expectancy within one year of the date of death. If their life expectancy was much longer than that of the owner, this could have resulted in lower required distributions and less taxable income each year to the beneficiary. 

What Happens If the Beneficiary Doesn't Stretch Out the IRA

A beneficiary who is eligible to stretch the required minimum distributions over their own life expectancy does not have to do so. They can liquidate the inherited IRA at any time, but this will result in the inclusion of the entirety of the funds in the beneficiary's taxable income for the year in which they were withdrawn. If the beneficiary does not need the money for some pressing reason, it's typically better tax-wise for them to take only the required minimum distribution each year.

Surviving Spouses Have Another Option 

A surviving spouse named as the primary beneficiary of a decedent's IRA has an additional option: They can roll the funds over from the inherited IRA into their own IRA. This allows them to treat the inherited IRA as their own, subject to their own RMD requirements and life expectancy. The Secure Act of 2019 has not affected this option.

IRA beneficiaries, including surviving spouses, usually have several options to choose from when deciding what to do with the account. The rules for these options can be complicated. A beneficiary would be wise to consult with an estate planning attorney, a financial adviser, or an accountant before making any decisions about how much to withdraw from an inherited IRA.