Jason Tank

Tank

In the real world, stretching hurts. Since I’m only about six months away from turning 50, I know this firsthand. Fortunately, I hear it’s not too late to work on it. But in the world of money, it is too late to stretch.

Prior to the start of 2020, people who inherited an IRA were allowed to slowly pay tax on the money. They could spread out their annual required minimum distributions from an inherited IRA over their lifetime. In some cases, beneficiaries were able to “stretch” the tax they owed over many, many decades.

But starting on Jan. 1, 2020, the rules for many IRA beneficiaries changed. To be precise, things changed for people who are not considered to be an “eligible designated beneficiary.” So, what does that mean?

You are not an eligible designated beneficiary unless you fall into one of these categories:

First, the rules didn’t change for surviving spouses. Second, beneficiaries who happen to be within 10 years of the age of the deceased IRA owner still get to use the stretch option. Next, the old rules still apply for beneficiaries who are disabled or chronically-ill. And, finally, beneficiaries who are still minors get the stretch option until they reach adulthood.

If you don’t fit the definition of an eligible designated beneficiary, your ability to do a lifetime stretch has been lost.

As background, Congress passed the SECURE Act in very late 2019.

The SECURE Act stipulated that new, non-eligible designated beneficiaries must distribute their entire inherited IRA within a 10-year period of the start of the year following the passing of the old IRA owner.

A new world of tax planning was born. To illustrate why proactive tax planning matters, let’s go through an example.

Samantha, age 48, inherits a sizable $1.5 million IRA from her father. Naturally, she leads a full and busy life. She doesn’t really like to talk about money all that much. Worse yet, she procrastinates on things she doesn’t like.

Samantha decides to invest the $1.5 million on her own. Things go along just fine for about seven years and, at age 55, she decides it’s time to really start planning for her eventual retirement. During her initial meeting with her new financial advisor, she hands over her big pile of investment statements and a couple of recent tax returns.

After some study, her advisor realizes she needs to break some difficult news to Samantha. While the good news is Samantha’s inherited IRA has grown to over $2 million, the truly terrible news is that it now needs to be fully distributed — and fully taxed — within three years. Samantha’s 10-year clock was ticking away like a tax bomb and she simply didn’t know it.

Of course, I’m certain Congress didn’t intend for this to happen to people. But, perhaps we can now see why there was such bipartisan support for the elimination of the IRA “stretch” option for many beneficiaries. After all, there are trillions of dollars currently held inside IRAs that are just waiting to be passed to the next generation.

Jason P. Tank, CFA, CFP® is both the owner of Front Street Wealth Management, a purely fee-only advisory firm and the founder of the Money Series, a non-profit program committed to providing open-access to financial education, for all. Contact him at (231) 947-3775, by email at Jason@FrontStreet.com and at www.FrontStreet.com.

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