What can I do instead of a Stretch IRA?
What are 7 alternatives to a Stretch IRA?
If you are not a designated eligible beneficiary, then you can no longer Stretch and Inherited IRA. Read my blog on the 10-year Rule and your Retirement Accounts to familiarize yourself with who can still Stretch an IRA, and the implications of being forced to take out an inherited IRA over 10-years instead os stretching it.
So, what are the 7 alternatives to the Stretch IRA?
7 Alternatives to the Stretch IRA
Here they are, in order of benefit:
- Roth Conversions
- 529 Plans
- Life Insurance
- Accumulation trusts
Let’s go over these stretch IRA alternatives and talk about the benefits of each.
Roth Conversions as an Alternative to Stretch IRAs
A series of partial Roth conversions is a powerful alternative to the Stretch IRA. If you have a high tax bracket heir, you can take advantage of your lower tax brackets to pre-pay the taxes.
The idea is to look at both your and your heir’s tax brackets (over your remaining life span and the 10-years they get to remove the IRA and Roth IRA) and determine the optimal tax brackets in which to pay taxes.
Roth conversions (for some) are the optimal alterative to the Stretch IRA. Who will pay the taxes on retirement accounts?
Yearly Gifting as a Stretch IRA alternative
Don’t forget to use your yearly $15k per person gift tax exclusion to give while you are living.
This gifting can be upstream gifting if you really want a tax-efficient way to give money, or it can be downstream gifting.
If you have to take out RMDs you cannot spend, getting them out of your estate early (as an estate freeze) makes sense so the growth happens outside of your estate.
CRUT as an Alternative to Stretch IRAs
Charitable remainder trusts are a more complicated idea, and I’m going to spend some time discussing them here. If you have charitable intent, a CRUT is a very interesting idea and worth considering if you need a Stretch IRA alternative.
What is a CRT? A CRUT?
Charitable Remainder Trusts can be Annuities (CRAT) or Uni-trusts (CRUT). Annuity trusts pay out a fixed amount of money every period, and thus are infrequently used.
Charitable Remainder Uni-Trusts, on the other hand, pay out a fixed percentage of the trust every year. Each year the value of the trust is recalculated, and the payment adjusted.
Remember, they are Charitable Remainder trusts, so promise at least 10% to the charity of your choice. If you want the charity to be your own DAF (donor advised fund), that is fine. (The Grandkids can give the money away!) The payment rate is actuarially determined based upon beneficiaries age, interest rates, and IRS tables. Usually, 5-8% is taken out each year, and at the end of the term—usually 20 years—at least 10% remains for charity.
What Goes in a Charitable Remainder Trust?
Many times, appreciated property (such as real property or stocks with a low basis) are donated. Since they donated to charity, you get the full amount deposited into trust, which can then be sold without capital gains. In addition, you also get a current tax write off on the present value of the future charitable donation.
In this case, we donate an Always Taxable account (the IRA) into a CRUT. No tax is due and the full amount transfers over to the trust. The payments to the beneficiaries, however, retain their character (Always Taxable) and are always taxable.
A CRUT as a Stretch IRA Alternative
Above, let’s look at a CRUT as a Stretch IRA alternative. This is a 50-year-old who inherits an IRA or a CRUT.
On the top in orange, she inherits an IRA and takes it over 10 years. Note this forces the taxable to be quite high over those 10 years, exposing the inherited money to higher marginal tax brackets over a shorter period of time. The light blue is the exposure to taxes from the inherited income.
The bottom graph shows the key tax components of the CRUT as a Stretch alterative. Dark Blue shows the income from the taxable annuity, which pays out over her lifetime. The green is the investment income which slowly increases over time with increasing slope as dividends and interest increase.
Note that you pay less in taxes over the first 10 years, but you continue to pay taxes on the CRUT over your whole lifetime.
In the end, CRUTs can pass on a steady stream of income, and in the right situation (especially if you have charitable intent), can be a very powerful way to efficiently dispose of large IRAs.
529 Plans as Stretch IRA Alternatives
This idea is a bit off the beaten path, but you can donate large sums of money to 529 plans. You can leave a legacy of education to your family, or you can consider using the 529 Retirement Plan.
Next, consider QCDs to lower your taxable income, which allows you to do more Roth conversions. In the end, you won’t leave more after-tax money to your children, but QCDs are one of the optimal ways to balance out your taxes during your lifetime which is a nice alternative to the Stretch IRA
Permanent Life Insurance as a Stretch IRA Alternative
Permanent Life Insurance has a bad reputation, but there are indications for permanent life insurance.
In fact, leveraging your Required Minimum Distributions is a great way to leave a non-taxable lump sum to your heirs.
Guaranteed Universal Life Insurance (GUL) is the cheapest, most effective way to build a death benefit. You can use second-to-die policies to increase the death benefit or lower the premiums. If you have extra RMDs and are not averse to using permanent life insurance, this is a real reasonable option.
Finally, you could leave your IRA to an accumulation trust and have the trust dictate the distribution of assets. Of course from a tax perspective this is a horrific idea, as all the income to the trust is fully taxable at trust tax rates.
But if you must replicate the Stretch IRA because you need to protect the money from creditors or control the money for the heir, and accumulation trust is a consideration.
Distributions of Inherited IRAs
The SECURE Act will force an Inherited IRA to be distributed over 10 years. There are no more RMDs (Required Minimum Distributions) from an Inherited IRA that allow it to be “stretched.”
You can take the Inherited IRA out as a lump sum on year one or year 10 if you wish, however there are tax implications! This inherited deferred income sits on top of all your other income. You pay taxes at your highest marginal tax bracket.
As an example of why we need Stretch IRA alternatives, I want to look at marginal tax rates for an inherited IRA if you take it out over 5 or 10 years, vs the Stretch IRA.
On top, with 5-year distributions, the total income starts around $200,000 and increases for 5 years as the inherited IRA is depleted. Income from the brokerage account starts at year two and slowly increases over time.
In the middle, note the 10-year distributions. Here, the total income starts around $150,000 and increases to $200,000 over 10 years. Income from the brokerage account starts later than in the 5-year distribution.
On the bottom, the income from the old inherited IRA slowly increases over the 20 years and continue on in retirement. Total income here starts just above $100,000 and doesn’t reach $150,000 until 10 years later. Income from the brokerage account stays tiny as well.
Note how the Stretch IRA will be missed! Not only do you pay less in taxes early on, you also get to keep the bulk of the money growing in tax-deferred status. This allows for massive inter-generational wealth transfer from retirement accounts.
Summary: 7 Alternatives to a Stretch IRA
Now that the Secure Act has passed, you will be forced to do a 10-year distribution from your inherited IRA rather than the old inherited IRA. This means less money for you now (due to current taxes) and in the future (due to loss of tax-deferral).
For most, a series of partial Roth IRA conversions might be the best Stretch IRA alternative.
If you need to control or protect the IRA, permanent life insurance or an accumulation trust are alternatives.
If you have charitable intentions, a CRUT is a nice stretch IRA alternative, and QCDs can allow you to increase your Roth conversions in a tax-efficient manner.
Finally, 529 plans for educational legacy and gifting while you are alive are always nice alternatives.
What can I do instead of a stretch IRA? There are some options as reviewed above, but the stretch IRA will truly be missed!