A Stretch IRA allows an IRA beneficiary the option to stretch the distributions from the IRA over their life expectancy. Recent legislation was proposed to limit stretch IRA distributions to 5 years. This proposal was part of a Senate Finance Committee Bill*. It was not included in House bill. This proposal was scheduled to be effective for people that die after 2012.
There were some limited exceptions to this. A surviving spouse, a child with special needs and a beneficiary that is no more than 10 years younger than the original account holder would not be subject to this proposal.
Here are 3 Reasons Why I Believe Limiting Stretch IRA’s to 5 Years is a Very Bad Idea:
By forcing beneficiaries to take distributions over only 5 years they may quickly go through this money. This is not how an inheritance is typically designed to work. Most people worked hard and saved to accumulate assets in their IRA. If they hadn’t used them up during their lifetime, they were often left for their children or grandchildren.
By making the distributions only over 5 years, it’s likely the income tax brackets will be higher because the distributions will be greater. Higher income tax brackets results in less cash to the beneficiaries. Having the ability to defer the distributions over your life expectancy will likely result in lower tax brackets through the years.
Many corporations terminated their pension plans years ago. Many were replaced with defined contribution plans, the most common one being a 401(k) plan. Now the majority of people covered by a pension plan are predominately limited to federal, state and municipal employees. Without a pension plan, many people will generally rely on their savings, 401(k) plan, IRA’s and Social Security. Without a pension plan, people are trying to create an income stream that they won’t outlive. Having the option of doing a stretch on an inherited IRA is a wonderful choice to have.
Are the rules for inherited IRA’s too complicated? Yes, I believe they are. Forcing beneficiaries to take distributions over 5 years is not the solution however.
Thomas F. Scanlon, CPA, CFP®
*Highway Investment, Job Creation and Economic Growth Act of 2012