Stretch IRA

A Stretch IRA was a popular and powerful estate planning strategy that allowed a non-spouse beneficiary, such as a child or grandchild, to “stretch” out distributions from an inherited Individual Retirement Account (IRA) over their own lifetime. This clever tactic maximized the account's tax-deferred growth, allowing wealth to compound for decades longer than it otherwise would have. However, this financial planning gem was largely eliminated for most beneficiaries by a major piece of U.S. legislation in 2019. Think of it as a legendary investment tool that has now been placed in a museum—valuable to understand, but no longer available for general use. Understanding its rise and fall offers crucial lessons about how changes in tax law can dramatically alter long-term wealth-building strategies.

Before 2020, the Stretch IRA was a cornerstone of multi-generational wealth transfer. The magic was in the math of Required Minimum Distributions (RMDs). When someone inherited an IRA, they were required to start taking RMDs—small, mandatory annual withdrawals. Under the old rules, the size of that RMD was calculated based on the beneficiary's life expectancy. This was a huge advantage for a young beneficiary.

Imagine 30-year-old Chloe inherited a $500,000 Traditional IRA from her grandfather. Based on her long life expectancy (perhaps another 55 years), her first RMD would be incredibly small (around $9,400). The remaining $490,600 would stay in the account, continuing to grow tax-deferred. Each year, she would take out a tiny sliver, allowing the vast majority of the nest egg to potentially grow into millions over her lifetime. It was the ultimate long-game strategy for passing on wealth.

The party came to a screeching halt with the passing of the Setting Every Community Up for Retirement Enhancement (SECURE) Act. To raise tax revenue, the U.S. government effectively dismantled the Stretch IRA for most beneficiaries. It was replaced by the 10-Year Rule. Under this new rule, most non-spouse beneficiaries who inherit an IRA must withdraw the entire balance of the account by the end of the 10th year following the original owner's death. There are no required annual distributions within this 10-year window, but the account must be empty by the deadline. This forces the beneficiary to realize all the taxable income in a much shorter period, often pushing them into a higher tax bracket and dramatically reducing the potential for long-term, tax-sheltered growth.

The SECURE Act didn't eliminate the stretch for everyone. A special class of beneficiaries, known as “Eligible Designated Beneficiaries” (EDBs), can still use the old life-expectancy rules.

• Surviving Spouses: A spouse who inherits an IRA has the most flexibility and can always treat it as their own, effectively continuing the stretch.
• Minor Children: A minor child of the original account owner can stretch distributions until they reach the age of majority (typically 18 or 21), but the 10-year rule then kicks in.
• Disabled or Chronically Ill Individuals: Beneficiaries who meet the official definitions of disabled or chronically ill can stretch distributions over their lifetime.
• Individuals Not More Than 10 Years Younger: A beneficiary who is close in age to the decedent (e.g., a sibling or partner) can also use the old stretch rules.

For everyone else—like adult children or grandchildren—the 10-Year Rule applies.

The demise of the Stretch IRA is a classic example of how “rules risk” can impact even the most carefully laid plans. For the long-term value investor focused on building and preserving multi-generational wealth, this change requires a strategic pivot.

1. Loss of a Compounding Supercharger: The ability to let an investment portfolio compound tax-deferred for an extra 40, 50, or 60 years was an incredible gift. That gift is now gone for most.
2. The Rise of the Roth: Converting a Traditional IRA to a Roth IRA during your lifetime is now a more compelling strategy. While an inherited Roth IRA is also subject to the 10-year rule for most beneficiaries, all their withdrawals are tax-free. This can save your heirs a massive tax headache.
3. Exploring Other Tools: Investors must now look to other vehicles to pass on wealth efficiently. This may include life insurance policies, which provide a tax-free death benefit, or setting up specialized trusts (like a Conduit Trust or Accumulation Trust) as the IRA beneficiary to control distributions.

Ultimately, the story of the Stretch IRA is a powerful reminder: a successful long-term investment strategy isn't just about picking great assets; it's also about understanding the ever-changing legal and tax landscape you're operating in.