What Is a Stretch IRA and How Does It Work?

A Stretch IRA was once a favored estate planning tool, allowing beneficiaries to extend withdrawals over their lifetime, maximizing tax-deferred growth. However, the SECURE Act of 2019 changed these rules, limiting most non-spouse beneficiaries to a 10-year withdrawal period. This shift accelerates tax liabilities and reduces long-term tax benefits.

Understanding these changes is crucial for anyone planning to pass on retirement savings efficiently.

Key Features

A Stretch IRA enabled beneficiaries to take withdrawals over their lifetime, preserving tax-deferred status and allowing continued investment growth. The longer the withdrawal period, the greater the potential for compounding returns.

The SECURE Act replaced this approach with a 10-year withdrawal rule for most non-spouse beneficiaries. While funds can still grow tax-deferred during this period, large withdrawals in a single year can push heirs into higher tax brackets.

Certain eligible designated beneficiaries (EDBs), including disabled individuals, chronically ill individuals, and minor children of the original account holder, qualify for extended distribution schedules under specific conditions. Proper estate planning is necessary to minimize tax consequences and ensure tax-efficient withdrawals.

RMD Requirements

Before the SECURE Act, non-spouse beneficiaries could calculate required minimum distributions (RMDs) based on their life expectancy, allowing smaller annual withdrawals and prolonged tax-deferred growth. Now, most must withdraw the full balance within 10 years, creating potential tax burdens.

For traditional IRAs, RMDs begin at age 73 under the SECURE 2.0 Act. When an IRA is inherited, distribution rules depend on whether the original owner had started RMDs. If they had, the beneficiary must withdraw at least the amount the deceased would have been required to take that year.

Since traditional IRA distributions are taxed as ordinary income, large withdrawals can push beneficiaries into higher tax brackets. Spreading withdrawals over multiple years or coordinating with other income sources can help manage tax liability.

Beneficiary Categories

The distribution rules for an inherited IRA depend on the beneficiary’s relationship to the original account holder. While most non-spouse beneficiaries must follow the 10-year rule, some qualify for more favorable schedules.

Spouse

A surviving spouse has the most flexibility. They can roll the inherited IRA into their own, delaying RMDs until age 73. If the deceased had begun RMDs, the spouse can recalculate distributions based on their own life expectancy, potentially lowering the annual tax burden.

Alternatively, a spouse can keep the account as an inherited IRA, which may be useful if they are younger than 59½ and need access to funds without incurring the 10% early withdrawal penalty. In this case, RMDs are based on the spouse’s life expectancy. Choosing the right option depends on factors such as age, income needs, and tax considerations.

Non-Spouse

Most non-spouse beneficiaries, such as adult children or siblings, must withdraw the full balance within 10 years. Unlike spouses, they cannot roll the account into their own IRA or delay distributions indefinitely.

There are no annual RMDs under the 10-year rule, but failing to withdraw the full balance by the deadline results in a 25% penalty on any remaining funds, reduced to 10% if corrected within two years. To avoid a large tax bill, beneficiaries may spread withdrawals over multiple years, aligning distributions with lower-income periods.

Minor Child

A minor child of the deceased account holder qualifies as an eligible designated beneficiary (EDB) and is not immediately subject to the 10-year rule. They can take RMDs based on their life expectancy until reaching the age of majority—typically 18. At that point, the 10-year rule applies, requiring full withdrawal by age 28.

This extended distribution period allows for additional tax-deferred growth, but large withdrawals in their late 20s could create tax challenges. Parents may consider Roth conversions before death to reduce future tax burdens, as Roth IRA distributions are tax-free if the account has been open for at least five years.

Distribution Timelines

The timing of withdrawals from an inherited IRA affects investment growth and tax planning. While the SECURE Act mandates a 10-year withdrawal period for most non-spouse beneficiaries, withdrawals can be taken at any time within the window. Delaying until the final year concentrates the tax impact, potentially increasing liability.

For large inherited accounts, spreading withdrawals over multiple years can help manage taxes while allowing continued investment growth. Market conditions may also influence timing. If the account holds stocks, delaying withdrawals during a market downturn avoids selling assets at a loss. Conversely, taking distributions during strong market performance locks in gains while preserving the remaining balance for future growth.

Tax Factors

The tax impact of an inherited IRA depends on the type of account, the beneficiary’s tax bracket, and the timing of withdrawals. Traditional IRA distributions are taxed as ordinary income, meaning large withdrawals can push beneficiaries into higher tax brackets. Spreading withdrawals over multiple years or coordinating them with lower-income periods can help manage tax liability.

Roth IRAs offer a different tax treatment. Since contributions were made with after-tax dollars, qualified withdrawals are tax-free. While the SECURE Act still requires most non-spouse beneficiaries to withdraw the full balance within 10 years, they owe no taxes on these distributions. This makes Roth IRAs advantageous for estate planning, as they allow beneficiaries to maximize tax-free growth. Converting a traditional IRA to a Roth before death can be a useful strategy, though it requires weighing the immediate tax cost of conversion against the long-term benefits for heirs.