Phil Roeder

Americans are losing a popular retirement tax strategy next year that allows the wealthy to leave large inheritances in retirement accounts. The Senate passed legislation on Thursday that eliminates a popular financial planning tactic called the "stretch IRA." The retirement bill, the Secure Act, was tucked into a bipartisan $1.4 trillion spending package that federal lawmakers had to pass by Friday to avoid a government shutdown. The House passed the spending package earlier this week. It now heads to the desk of President Donald J. Trump, who is expected to sign it. The stretch IRA — used primarily by Americans who have saved a substantial amount of money in their retirement accounts — applies to beneficiaries of individual retirement accounts and certain workplace retirement plans like 401(k) plans. Current tax rules state that beneficiaries, such as children and grandchildren, who inherit retirement accounts when the account owner dies must take distributions from those accounts over a certain time period. Today, that timeframe can be lengthy since it's based on the beneficiary's age and life expectancy. A 40-year-old inheriting a deceased parent's IRA, for example, could theoretically take distributions from the account over a period lasting more than three decades. However, the Secure Act significantly compresses the window of time for beneficiaries to take such distributions, which will have broad implications for many Americans, potentially even those of more modest incomes.

The new rules around the stretch IRA require beneficiaries of 401(k) plans and IRAs to withdraw all the money from inherited retirement accounts over 10 years. Taxpayers would have flexibility around when they take the distributions — they could withdraw an equal amount of money each year from the account or decide to withdraw all funds in year 10, for example. This would be true for both traditional, pretax retirement accounts and tax-free Roth accounts. Failing to withdraw funds within the 10-year period would result in a 50% tax penalty on assets remaining in the account. The elimination of the stretch IRA has been hotly contested in Washington. Opponents of curtailing the strategy contend the new rules are punitive for taxpayers who have structured their financial plans to leave large inheritances in retirement accounts for children and grandchildren. Proponents of upending the status quo say retirement accounts were never meant for estate-planning. New rules cut tax benefits to consumers in two primary ways, according to Jamie Hopkins, the director of retirement research and vice president of private client services at Carson Group, a financial advisory firm based in Omaha, Nebraska. More from Personal Finance

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Assets held in an inherited retirement account would have a shorter amount of time to grow on a tax-deferred basis, meaning overall account size would be smaller in most cases. Withdrawals will also be larger, since they're compressed into a shorter frame of time, making it more likely that beneficiaries of a pre-tax account will be pushed into a higher income-tax bracket when they take distributions. For example, the beneficiary of a $1 million account could withdraw roughly $33,000 a year over 30 years under current rules; however, that would be $100,000 a year under new rules. "For most people, that would push them into a higher tax rate," Hopkins said. The Congressional Budget Office in April projected the elimination of stretch IRAs and workplace retirement plans would raise nearly $16 billion for the federal government over a decade. Significantly, individuals affected by this change in tax law only have a short time to amend their financial plans. Taxpayers who inherit a retirement account from an account owner who dies after Dec. 31, 2019 would be subject to the new distribution rules. Accounts of those who die before the end of the year would be subject to the old distribution rules. "In some cases it may be better to die on Dec. 31, 2019 than Jan. 1, 2020," said David Levine, an attorney at Groom Law Group.