The End of the Stretch IRA?
By Letha Sgritta McDowell, CELA CAP
Tax deferral has long been one of the most powerful money saving strategies in existence and few options rival the concept of the stretch IRA. To understand the stretch IRA, we must first understand why the IRA (or any other tax-deferred savings vehicle such as a 401(k), 403(b), SIMPLE, etc) is such a powerful money saving tool. If an individual invests $5,000 each year in an IRA beginning at age 29 and retires and stops contributing to the plan at age 65, then their IRA balance would be approximately $796,687 at retirement age. This assumes an average rate of investment return of 7% (the S&P 500 averaged 10.3% between the years 1970 and 2016). Keep in mind the contributions aren’t taxable and neither are the earnings. Current income tax rules require that minimum distributions be taken from the account beginning at age 70 ½ in order to ensure some income tax is paid on that which has not yet been taxed. If the account owner dies and there are funds left in the account and they have named a beneficiary, then the beneficiary may “roll” the account into her or her own IRA, and then he or she must also take distributions from the account. However, the distributions must be taken over the life expectancy of that beneficiary. In many cases, the named beneficiary is younger than the original account owner thereby requiring a smaller percentage be taken annually. In the interim, the inherited account will continue to grow free of income tax. This phenomenon is commonly called the stretch IRA.
Using the above example, assuming a withdrawal rate of just the minimum required distribution of the original IRA owner beginning at age 70 ½ with the same continued rate of return, that same IRA is worth $1,462,161 if the owner dies at the age of 85; the increase being due to tax deferred growth. Then, assume the named beneficiary of the IRA is 55, and he or she rolls the IRA into his or her own IRA and begins taking only the required minimum distributions. Assuming the same 7% growth rate assumed with the initial IRA, the funds will last until the beneficiary turns 84, at which time the IRA value and required minimum distribution is the same amount. That amount being $236,569.
The above illustrates how a total investment of $180,000, when allowed to grow tax free, results in a large accumulation of wealth. In the above example, the IRA pays out a total of $6,999,418 between the original IRA owner and the beneficiary. For years attorneys, accountants, and financial advisors have stressed the power of this savings to clients and their families. And, for added protection, attorneys have strived to ensure that such accounts left to trusts for the benefit of family members also received the same tax deferred treatment. Much billable time and attention has been paid to preserve this tax-deferred transfer of wealth.
Currently, there are bills pending in both the House of Representatives and the Senate which would severely reduce or eliminate the stretch IRA. House Resolution 1994 (also known as the SECURE Act) proposes to raise the age for requiring minimum distributions to 72 but eliminates the stretch provisions which allow a beneficiary to take required minimum distributions over his or her life expectancy. Instead, the new law proposes to require a beneficiary to withdraw inherited funds over a period of 10 years or less. The bill does include some exceptions such as for a spouse, minor child, a child with a disability, or a beneficiary who is chronically ill. The equivalent bill in the Senate is Senate bill 3471. The Senate version proposes to require distributions from an inherited tax deferred account be made over a period of 5 years (instead of lifetime) but is only applicable if the total of all such tax deferred accounts exceeds $450,000. The Senate bill also provides for exceptions for the spouse, minor child, a child with a disability or person who is chronically ill.
These new bills requiring inherited funds be withdrawn and taxed will significantly reduce the amount allowed to accumulate and will reduce the ultimate pay out of the savings. While there are differences in each bill which would need to be rectified before it could pass and be signed into law, these bills have bi-partisan support which is rare and there may be a push to pass the bill in order to show constituents that Congress can accomplish something. Certainly this possible change will likely have a large impact on beneficiaries both from an income tax perspective and from a financial planning standpoint. Should some version of these bills pass, many will need to revisit both their estate and financial plans. Hook Law Center will be sure to monitor this legislation to inform clients of any final change.
Ask Kit Kat: Oyster Castles
Hook Law Center: Kit Kat, what can you tell us about oyster colonies in the Elizabeth River which runs through Norfolk, Virginia?
Kit Kat: Well, this is thoroughly fascinating! Scientists have long planted square concrete blocks with irregular heights and hollow centers in local waters to serve as a base for baby oysters to attach to and grow to form a reef. However, now environmental scientists think they have improved on the concept. Their new concrete blocks still have the same outer dimensions, but they have filled in the square with towers and mounds, so that the new blocks resemble something like a Disneyland castle. Evelyn Tickle, the head of GROW Oyster Reefs, says oysters in these new blocks can grow and “arch over … to establish their own reef. It establishes a natural-looking reef.” Reefs are important because they can serve as a buffer to protect shorelines during storms. GROW Oyster Reefs is based in Charlottesville, VA, but RISE, a Norfolk non-profit, awarded them a $285,000 grant to conduct the trial.
The concept of this new type of block is based on study of actual reefs—how different shapes work to encourage growth. Over the years, various materials have been tried—reg. concrete building blocks and even coal ash. Tickle’s blocks, however, are made of a specialized concrete that imitates the actual composition of an oyster shell. Her hope is that the new baby oysters will actually receive nourishment from the blocks which will, in turn, foster growth. Tickle also says, with her system, blocks will not need to be re-planted every year. Hopefully, her blocks will spur new growth on their own. Tickle hopes to open an office in the Hampton Roads in the near future. She is that confident of her product.
There are 3 locations in the area that have been planted with the new concrete blocks—along the Elizabeth River south of I-264, one in the Lynnhaven River, and one each on the ocean and bay sides of the Eastern Shore. This was done in mid-May of this year. Joe Rieger, deputy director of restoration for the Elizabeth River Project, said these locations will be checked in a couple of months to determine progress. Time will tell how successful this endeavor has been.
(Katherine Hafner, “Unique tile gives oysters a new castle,” The Virginian Pilot, May 20, 2019, p. 1 & 10)