How the Elimination of the Stretch IRA Affects Planning for Special Needs Families

One of the biggest changes resulting from the recently passed SECURE Act legislation was the elimination of the Stretch IRA provision which allowed beneficiaries to take IRA distributions over their life expectancy (as opposed to the life expectancy of the original owner) . 

Fortunately, individuals with disabilities are still able to stretch any inherited IRAs over the course of their lifetime; however, their siblings do not have this ability which poses a potential challenge for special needs families. This article discusses how the elimination of the stretch IRA will affect estate planning for special needs families.

What is the Stretch Beneficiary IRA?

In the past when someone inherited an IRA or 401K, they would have to take out minimum annual withdrawals over their life expectancy. As an example, let’s say an adult child inherited an IRA from their parents at age 25 and had a life expectancy of 95. Their required minimum distributions would be based on their living 70 years, thus giving that younger beneficiary the ability to spread out the proceeds over their lifetime, thus the name Stretch IRA. Of course the beneficiary could elect to take out more than the minimum, but since all withdrawals count as taxable income, the ability to take out a smaller amount gives the beneficiary the flexibility of how to manage their tax bill more efficiently over their lifetime.    

A slight wrinkle to the stretch provision was how an IRA got distributed if a trust was named as a beneficiary with shares of the trust being split among several people. In this case, the IRA going to the trust would be stretched over the life expectancy of the oldest person inheriting shares of the trust. Thus, if the child with a disability was younger than his siblings, the IRA payable to the trust would be distributed over the life expectancy of the oldest sibling instead of the longer life expectancy of the child with a disability. 

The SECURE Act and Stretch IRAs

The SECURE Act has eliminated the Stretch IRA for most new beneficiaries starting January 1, 2020, with some key exceptions including:

• Spousal beneficiaries
• Disabled beneficiaries
• Chronically Ill beneficiaries
• Individuals who are not more than 10 years younger than  the decedent
• Certain minor children, but only until the age of majority

For all other beneficiaries of IRAs, the proceeds from an inherited IRA needs to be completely withdrawn by the 10^th year following the year of inheritance (aka “the 10-year rule”).  Importantly, the inherited IRA can be completely emptied anytime within that 10-year period. Fortunately, the majority of individuals with disabilities will continue to be able to stretch their inherited IRAs, provided they have sufficient documentation (e.g. doctor’s note) showing that the person has a permanent disability that prevents gainful employment.  

In fact, individuals who share IRA proceeds from a trust with their siblings are slightly better off after the law change to the extent that the IRA for the individual is stretched now over their own life expectancy as opposed to the life expectancy of an older sibling.

How the Secure Act Affects Estate Planning for Special Needs Families        

For families who do not have any typical children or who were intending to leave their inheritance exclusively for the benefit of the individual with disability, the new law has no effect on their estate planning. For those special needs families whose intention is to divide shares of the family estate through some mechanism, like a special needs trust, the law may prompt them to reconsider how those shares might be divided between siblings, since the “10 year rule” might have a significant effect on the future taxes of the beneficiaries.

For example, a family who has both Roth IRAs and regular IRAs to leave for their children, may want to redistribute more of the Roth IRAs to the typical children who maybe more likely to have greater future taxable income.   Although tax planning should not be the primary concern in any estate plan, the change in the law  should motivate families to reevaluate their estate plans to consider the tax implications of their trust or will on their loved ones.