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2015 Federal Budget – No Non-Spouse Stretch IRA

The proposed 2015 Government Budget is full of tax code changes. Some, bigger and more impactful that others. Today, as the title shows, the budget, if passed will eliminate the stretch IRA.

Stretch IRA? It’s actually a term used by brokers and advisors, but it’s not an IRS term. The stretch refers to the fact that if one dies and leaves their IRA to a non spouse, current law permits withdrawals over the life expectancy of the beneficiary. Here’s the cool thing – if you are, say, 30 years old and inherit an IRA, your first year withdrawal is just under 2% of the account value. To be precise, a $500K IRA and an RMD divisor of 53.3, from IRS Publication 590, result in a required withdrawal of $9381. This small withdrawal will have a small tax impact, for the traditional pre-tax IRA, it’s taxed at one’s marginal rate, but this wont be enough to send the beneficiary into the next bracket or the one after that as would a complete withdrawal of the entire account. Perhaps more important, this withdrawal is far less than one should expect from the market long term, and hopefully the account will continue to grow for years to come.

This may all be in the past. The new budget proposes that a non-spouse will not have the lifetime withdrawals, but must take the assets of the account by the end of five years. What does this mean for our 30 year old? A $100K first year withdrawal. This would easily push a single person in the 15% bracket right into the 25% and 28% brackets, and put the longer term growth in jeopardy.  It’s partially psychological, but money in a non-retirement account is more easily spent.

The impact won’t be on us, but to our loved ones. I Disagree with this proposal and hope to see it deleted from the budget. If the intent is to go after the “Romney” sized IRA accounts, it’s easy enough to offer a maximum account size. Too many people of modest means have trusted the stretch rules to use their IRAs as a “poor man’s” trust, and this should be left in tact.

  • Dilip Sarwate March 25, 2014, 5:29 pm

    Doesn’t the new budget simply restore the non-spouse IRA rule to what it used to be? I remember a time when non-spouses were required to take a distribution of all the money in the inherited IRA within 5 years, and then this was changed (Bush tax cuts?) to allow the stretch rule.

  • Joe March 25, 2014, 8:43 pm

    I went back to 1995 for Pub 590 and see “Over the life of the designated beneficiary” on page 24.
    I don’t recall there was ever a forced 5 year rule. Let me know if you uncover something reflecting this.

  • John C @ Action Economics March 28, 2014, 7:00 am

    This seems to me like its designed to be an extension of the estate tax. While its a major change for anyone inheriting an IRA it is something that occurs relatively infrequently, compared to say earning weekly income, so they probably expect much less push back than they would receive on an increase in income tax brackets. This is another example of the federal government concentrating on “the edges” instead of truthfully addressing the budget deficit. I haven’t taken a look at this proposal yet, did it specify an expected yearly revenue from this change?

  • Joe March 29, 2014, 7:23 am

    Thanks for visiting. I agree, this is not a change to the tax code portion that impacts us in our weekly pay check. But the IRA has been around for a long time, and is more widespread than the 401(k) or other retirement accounts.
    From where I sit, it’s less about how many than it is about who and how impactful. Any lower income couple might be in the 15% bracket, but the forced higher withdrawal pushes them to 25%. In the extreme case, an older couple might be retiring 5 years out and would otherwise be at 10% after they quit work, but the forced withdrawal is far more costly while they are still working. Presumably this was intended to hit the rich, Romney sized IRAs. It will have the unintended consequence of (potentially) hitting all of us.

  • Arminta September 22, 2015, 1:24 pm

    I believe the Stretch IRA refers to stretching out the IRA to beneficiaries further down the line – not the initial beneficiary but THEIR beneficiaries and theirs, etc. I also believe Dilip Sarwate is correct about the earlier 5 year rule. Non-spouse beneficiaries used to have to take the funds by the end of 5 years but a few years ago it was changed so that the non-spouse could inherit the IRA and treat it as their own – however, it has to be titled as an Inherited IRA the next beneficiary has to keep the same payout schedule as the original non-spouse inherited beneficiary has in place.

  • Joe October 2, 2015, 5:01 pm

    Stretch refers to the first beneficiary ability to take withdrawals over her own lifetime. The budget plan included a provision to limit the beneficiary option to 5 years, but this never passed.

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