Many of our clients have questions about how they can use their individual retirement accounts advantageously when they are devising their estate plans. There was once a tried-and-true strategy called the “stretch IRA” that could be used to great advantage under certain circumstances.
However, this approach is no longer possible because of some changes to the federal laws. We will explain the changes as we go through the details as they stand today.
Traditional Individual Retirement Accounts
With a traditional IRA, you make contributions before you pay taxes on the income. As a result, you get a tax break, because your taxable income is reduced by the amount of your contributions.
On the other side of the coin, when you take distributions, they are subject to regular income taxes. You are allowed to start taking penalty free withdrawals when you are 59.5 years old.
Because the IRS wants to start collecting money from you eventually, there is an age at which you must begin to take mandatory minimum distributions.
The law that we referred to in the opening is called the SECURE Act. This mandatory distribution age used to be 70.5, but it has now been raised to 72.
Another change is the fact that you can continue to contribute into a traditional individual retirement account indefinitely, even after you reach the mandatory distribution age. Before the SECURE Act went into effect, contributions had to stop when an account holder reached the age of 70.5.
Roth IRAs
A Roth individual retirement account works in the reverse manner when it comes to taxation. You make contributions into the account after you pay taxes on the income, so if you decide to take distributions, they are not subject to taxation.
We are saying “if” because you are never required to take mandatory minimum distributions. The other details are in line with traditional individual retirement accounts.
Inherited IRAs
When a beneficiary that is not a spouse inherits an individual retirement account, the tax situation is the same as it would be for the primary account holders. Distributions from a traditional account are taxed, and Roth beneficiaries do not have to pay taxes on the distributions.
In both instances, beneficiaries are required to take mandatory minimum distributions.
Prior to the SECURE Act changes, a beneficiary could take only the minimum that was required for an open-ended period of time. This was called “stretching” an individual retirement account.
From an estate planning perspective, this was a great strategy to implement, because the stretching the IRA would maximize the growth benefits. It was especially useful for the Roth IRA because of the tax-free distributions.
Now, all of the assets in either type of individual retirement account must be transferred within 10 years of the death of the original holder of the account.
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Mr. Nirenstein is licensed to practice before the courts of the State of Connecticut and the United States District Court. He is a member of the Connecticut and Hartford County Bar Associations, and the Estate and Probate, Elder Law, Business Law and Real Estate Sections of the Connecticut Bar Association.
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