What Will Happen To the Stretch IRA?

By Sarah Brenner and Beverly DeVeny
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This week’s Slott Report Mailbag answers questions on the tax “sweet spot” in retirement, the tax and penalty impact on a non-spouse beneficiary’s inherited Roth IRA distributions and the future of the stretch IRA. As always, we recommend that you work with a competent, educated financial advisor to keep your retirement nest egg safe and secure. You can find one in your area here.

1.

Ed,

I have a question.

I am a 72-year-old surgeon who is still working. I have over $1 million in my IRAs. Currently, when I take my 4% yearly required distribution, I pay a fat tax since I am still earning $200,000/year.

I have over $1 million outside my IRA to live off as soon as I retire. I have not decided when I will retire, but it’s coming soon. My question is: if most of my income in retirement is my required distribution, am I then in a sweet spot to be hit by taxes?

Sincerely,

Robert Wayne

Answer:
Your required minimum distribution (RMD) is usually taxable as ordinary income. It is included with any other income you might have when determining your total tax liability for the year. Therefore, how big of a tax hit you will take when you retire depends on many factors. Your RMD is just one of them. You may want to discuss your specific situation with a knowledgeable tax advisor.

2.

I understand that the distribution from an inherited non-spouse Roth IRA is tax-free if the five-year period is met. Is the distribution also penalty-free if the beneficiary is under 59 ½ years old? Also, on the distribution from a Roth IRA, what comes out first: the earnings or the contributions if the five-year period is not met?

Answer:
Good news! Distributions from inherited Roth IRAs to beneficiaries are always penalty-free, even for beneficiaries under age 59 ½. When a distribution is taken from a Roth IRA, tax-year contributions are considered distributed first, then converted funds, and finally earnings. Only earnings will be taxable if the five-year period is not satisfied.

3.

Regarding the much talked about end to the “stretch” IRA. Do you expect that the possible change in inherited IRAs will allow existing inherited IRAs to remain as they are – and be depleted over a lifetime – and only impact new inherited IRA accounts going forward – so that existing inherited IRAs will be “grandfathered” in?  Or do you expect the possible change will mandate that ALL inherited IRAs, both existing and new, will be required to be “depleted” within five years.  

Answer:
It is hard to say with any certainty what future legislation will look like. Congress can be unpredictable! However, the legislative proposals we have seen that eliminate the stretch IRA would not apply to existing beneficiaries, but only to new beneficiaries when the IRA owner dies after a specified date. After the specified date, the death of a beneficiary using the stretch would end the stretch for a successor beneficiary as well.