First, what is a stretch IRA? It’s actually not an IRS term, but more like a nickname. It refers to the fact that an IRA inherited by a non-spouse can be withdrawn over the beneficiary’s lifetime. The beneficiary refers to the IRS publication 590 to find their minimum withdrawals which must be taken each year based on their age. For example, a 20 year old has a divisor of 63, which means his withdrawal is based on the prior December 31 IRA balance divided by 63 or just over 1.5% of that balance. The divisor drops by one each year, so this fellow will see that divisor drop to 25 a full 38 years later at age 58. 1/25 is 4%, so for all this time and years to come it’s possible the account will grow far faster than the withdrawals. Most important, taxes are only due on the amount withdrawn, so even a starting windfall value of $1 million requires a minimum distribution of $15,873 for this 20 year old. Now, for the news…
Just a few weeks ago, the Senate Finance Committee was reviewing a new highway bill and the committee chairman Max Baucus saw fit to tack on a provision that would eliminate the favorable terms for inherited IRAs. Spouses would be permitted to withdraw over their lifetime, as would the disabled. Minor children would also get the stretch, but older children or other beneficiaries would have 5 years to take their withdrawals. Even people of modest means could easily be thrown into the top tax bracket based on these forced withdrawals.
The story ends with good news, however. There was enough public outcry that the senate removed this provision.
I know that there’s a feeling that the inherited IRA favors the rich, but this is no different than any benefit. Mortgage interest deduction offers a higher benefit for a million dollar mortgage compared to a hundred thousand dollar mortgage. The capital gain rate assumes that one has such investments, and the rich are more likely to have stocks to take advantage of the cap gain rates. What the senate might have considered is a permanent fix to the estate tax, a reasonable exemption that most would consider fair, and as the estate includes retirement account assets, the stretch for beneficiaries can be left intact for good. It’s behind us, but only for now.