4 Timeless Tax Planning Insights for Advisors

3. Loss of Stretch IRAs Is a Genuine Planning Challenge for HNW Clients

Though the policy change happened nearly three years ago, Steffen says, the elimination of the stretch IRA continues to be an important point of focus when factoring taxes into clients’ financial plans.

“The big thing a lot of tax-conscious advisors are focusing on right now is what is going on with the new 10-year window for distributing inherited IRAs,” Steffen notes. “Under the current framework, most beneficiaries, not including spouses, have to distribute the value of the IRA within 10 years.”

In many cases, Steffen says, this new framework will mean that clients face a bigger tax burden.

“You have to be prepared to have that tough conversation because, in most cases, the client and their heirs are going to pay more taxes because of this,” Steffen says. “You can’t avoid that basic fact, but you can take steps to mitigate that loss, depending on the client’s unique situation.”

Steffen says one key challenge is that it has been unclear whether a client must start taking distributions in the first year after the original IRA owner’s death, or if it would be possible to backload the distributions in the 10-year window.

The confusion surrounds those beneficiaries who inherited an IRA in 2020 or later and were subject to the 10-year rule, where the entire inherited IRA balance would have to be withdrawn by the end of the 10th year after death.

In regulations proposed earlier this year, the IRS says that if these beneficiaries inherited from someone that was already taking required minimum distributions, then not only are they subject to the 10-year rule, but they will also be required to take RMDs for years one through nine after death.

Steffen says the required distributions in years one through nine may disadvantage those IRA inheritors who are near their own retirement, as it would make sense for many of these people to back-load the distributions until they stop generating their own income.

Under the proposed regulations, it appears this backloading won’t be possible in cases where the IRA owner had already initiated RMDs, but a newly published IRS notice provides helpful relief by establishing that the normal 50% penalty for missed RMDs will not apply to such beneficiaries for 2021 and 2022. The IRS says it will finalize these regulations soon.

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