The Death of the Stretch IRA: Why Your Kids Will Hate Your Inheritance
The Death of the Stretch IRA: Why Your Kids Will Hate Your Inheritance
๐ WHO THIS IS FOR
- Target Profile: Parents with large IRAs ($1M+) who intend to leave them to adult children.
- Primary Objective: Intergenerational Wealth Transfer (Minimizing the tax impact on heirs).
- Not Suitable For: Childless couples or those leaving assets to spouses (Spouses are exempt from the 10-Year Rule).
EXECUTIVE SUMMARY
- The Old Rule: Before 2020, if you left an IRA to your child, they could “stretch” the distributions over their entire life expectancy (e.g., 50 years). This allowed massive tax-deferred compounding.
- The New Rule: The SECURE Act killed the stretch. Now, most non-spouse beneficiaries (children) must empty the inherited IRA within 10 years of the parent’s death.
- The Impact: This forces a massive acceleration of income. If your child inherits a $2M IRA at age 50 (peak earning years), they must add ~$200k/year to their taxable income, likely pushing them into the top bracket (37%).
- Authority Baseline: This analysis is based on the final IRS Regulations for the SECURE Act, confirming the strict 10-year liquidation requirement for “Designated Beneficiaries.”
You spent a lifetime deferring taxes in your IRA. Now, the IRS wants its cutโfast. Leaving a large Traditional IRA to a high-earning child is no longer a gift; it is a tax bomb. Strategic Disinheritance of the IRA (spending it down) or Roth Conversion (paying tax at your lower rate) are now the primary defenses against the 10-Year Rule. According to Team BMT Analysis, the “Stretch IRA” has been replaced by the “Roth Conversion Ladder” as the dominant estate planning tool. Source: Kitces.com / Ed Slott’s IRA Advisor
Scenario: Dad dies leaving a $2M IRA to Daughter (Age 50, earns $200k/year).
- Old Law (Stretch): Daughter takes RMDs of ~$30k/year.
Tax Impact: Minimal. Stays in 24% bracket. Tax deferral lasts until she is 85. - New Law (10-Year Rule): Daughter must withdraw roughly $200k/year to empty it.
Total Income: $200k (Salary) + $200k (IRA) = $400k.
Tax Impact: Pushed into 32% or 35% bracket. Plus NIIT (3.8%).
Result: The family loses an extra 10-15% of the legacy to taxes compared to the old rules.
BMT Verdict: Do not leave Traditional IRAs to high-earning children. It is the most tax-inefficient transfer possible. Leave them Step-Up assets (Real Estate, Brokerage) or Roth IRAs. Spend your Traditional IRA on your own lifestyle or convert it to Roth while you are alive (at lower tax rates).
Inheritance Tax Efficiency
| Asset Type Left to Heirs | Tax Paid by Heir (Estimated) |
|---|---|
| Roth IRA ($1M) | 0 |
| Brokerage Stock ($1M) | 0 |
| Traditional IRA ($1M) | 350000 |
*Chart Note: The Traditional IRA is the only asset that carries a “mortgage” payable to the IRS. The 10-Year Rule forces this mortgage to be paid off rapidly, often at the highest possible tax rates.
Regulatory Update: In 2024, the IRS clarified that if the decedent had already started taking RMDs, the beneficiary must continue taking annual RMDs during years 1-9, AND empty the account by year 10. You cannot just wait until year 10 to withdraw everything. This “At Least As Rapidly” rule further reduces planning flexibility.
โ BOUNDARY CLAUSE: This Structure Breaks Down If:
- Beneficiary is “Eligible Designated” (EDB): Spouses, disabled persons, chronically ill persons, and children under 21 are EXEMPT from the 10-Year Rule. They can still stretch.
- Charitable Intent: If you plan to give to charity anyway, leaving the IRA to charity avoids 100% of the tax. The 10-Year Rule is irrelevant for charities.
Execution Protocol
Calculate your current tax bracket vs. your heir’s future bracket. If you are in the 22% bracket and your child will be in the 32% bracket, convert the IRA to Roth NOW. You pay the tax at 22% to save your family 10%.
Withdraw funds from the IRA (pay tax), and use the net proceeds to buy a Life Insurance policy in an ILIT. The death benefit passes to heirs income-tax-free and estate-tax-free, bypassing the 10-Year Rule entirely.
Leave the IRA to a Charitable Remainder Trust (CRT). The CRT pays your child an income stream for life (effectively restoring the Stretch), and the remainder goes to charity. This is the only way to legally bypass the 10-Year limit for a healthy adult child.
The rules of inheritance have changed fundamentally. Old estate plans drafted before 2020 are now dangerous “tax traps.” Review beneficiary designations immediately.
WEALTH STRATEGY DIRECTIVE
- Do This: Change your beneficiary designation. Name your Spouse as Primary (to get the stretch) and name a Charitable Trust or Low-Income Grandchildren as Contingent (if applicable) to mitigate taxes.
- Avoid This: Leaving an IRA to a “Conduit Trust.” Before 2020, this worked. Now, a Conduit Trust forces the 10-Year Rule distribution to flow through to the beneficiary rapidly, destroying the trust’s protective purpose. Switch to an “Accumulation Trust” (but beware high trust tax rates).
Frequently Asked Questions
Does the 10-Year Rule apply to Roth?
Yes. Inherited Roth IRAs must also be emptied in 10 years. However, the withdrawals are tax-free. The “cost” is simply the loss of future tax-free growth, not an immediate tax bill. This makes Roth the superior inheritance vehicle.
Can I leave it to grandchildren?
Yes, but they are also subject to the 10-Year Rule (unless they are minors, in which case the clock starts when they turn 21). Leaving to low-income grandchildren (students) can be smart as they can withdraw at 0-10% tax rates.
What is the penalty for missing the deadline?
Massive. The penalty for failing to empty the account by year 10 is 25% of the remaining balance (reduced to 10% if corrected promptly). It is one of the harshest penalties in the tax code.