A stretch IRA is an inherited individual retirement account whose beneficiary was eligible to "stretch" the required minimum distributions over a longer period of time, based on their own life expectancy. The SECURE Act, signed into law in 2019, eliminated this loophole for non-spouse beneficiaries.
Definition and Examples of a Stretch IRA
A stretch IRA is an individual retirement account one inherits and that formerly allowed its new owner to extend, or "stretch," the required minimum distributions (RMDs) over time. As RMDs are determined by the account holder's life expectancy, beneficiaries were able to reset the length of time used to calculate the distribution. Life expectancy is determined by the applicable IRS life expectancy table. Doing so would allow the funds in the account to continue to grow tax-free.
The Setting Every Community Up for Retirement Enhancement (SECURE) Act, an expansive retirement bill that was signed into law in December 2019, eliminated the “stretch IRA,” which allowed non-spousal beneficiaries to withdraw assets of inherited accounts over their lifetimes. Now, those who inherit an IRA have 10 years to withdraw the assets—however, or whenever they’d like. Spouses and disabled beneficiaries are among the few exceptions to the rule.
How Did Stretch IRAs Work?
Any individual beneficiary, such as a child, grandchild, niece, nephew, or even a friend, was eligible to stretch an inherited IRA. Charitable organizations and trusts were not eligible because they do not have life expectancies.
Required Minimum Distributions
A required minimum distribution is an amount that must be withdrawn from certain retirement plans each year. That's because 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 when funds are taken. 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.
The owner of the IRA cannot leave the account intact indefinitely, allowing it to continue to grow tax-free, so funds must be withdrawn, and on a timeline that eventually depletes the account and exposes those funds to income tax.
If account holders do not withdraw the funds 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 would have resulted in lower required distributions and less taxable income each year to the beneficiary. It also would have allowed the funds in the account to continue to grow tax free.
A beneficiary who was eligible to stretch the required minimum distributions over their own life expectancy did not have to do so. They could have liquidated the inherited IRA at any time, but this would have resulted 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 did not need the money for some pressing reason, it was typically better tax-wise for them to take only the required minimum distribution each year.
Subsequent to the SECURE Act, non-spouse beneficiaries cannot extend the distribution window beyond 10 years.
Surviving Spouses Still Have Another Option
A surviving spouse named as the primary beneficiary of a decedent's IRA has an additional option beyond liquidating the account or adhering to the 10-year window: 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.
- Stretch IRAs allowed beneficiaries of an inherited IRA to extend the period of time required to withdraw funds from the account based on their own life expectancies rather than the original account holder's. This would allow the account to continue to grow, and to avoid income tax.
- The SECURE Act of 2019 eliminated this loophole for most beneficiaries.
- Non-spouse beneficiaries have 10 years after the death of the original account holder to completely withdraw funds from the inherited IRA.
- Spouse beneficiaries may roll an inherited IRA into their own IRA, effectively resetting the RMD to their own life expectancies.