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.