Is this the end of the 'stretch' IRA?

Money stretched
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IRAs aren't just for retirement planning. Many investors use them as estate planning tools, since heirs can let the money remain in the account for years while it grows and take distributions as needed.

Under current rules, beneficiaries can space out the distributions of inherited IRAs over a few years or over the course of their lives, which means the money can remain in the account for decades and continue to grow and distributions can be spread out to minimize the tax bill. That would end for many beneficiaries under a new provision in President Barack Obama's proposed 2016 budget.

If the provision is passed, almost any non-spouse beneficiary would be forced to withdraw all of their inherited retirement accounts by the end of the fifth year after the account owner has died, effectively killing what's known as the "stretch IRA" and the tax benefits that come with it. (Certain beneficiaries would be exempt, like those who are disabled, chronically ill or aren't more than 10 years younger than the retirement account owner who died.)

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The result could be a huge tax bill for heirs, who could no longer space out distributions. Even those who inherit a tax-free Roth IRA account could be affected, as they might be bumped into a higher tax bracket if they're forced to empty the account within five years.

On the bright side, the budget also includes some potential tax relief for heirs. Another provision would allow non-spouse beneficiaries to move money from one inherited retirement account to another through a 60-day rollover without paying taxes.

"If you accidentally try to do a 60-day rollover now as a non-spouse beneficiary, it's all taxable in one shot, so the taxes can be huge. It can have a devastating impact," said Jeffrey Levine, a CPA and an IRA technical consultant with Ed Slott & Co. "There's absolutely no good, compelling reason not to incorporate that into the budget. No one would get hurt, but a lot of people would be helped."

Chances of adoption of "stretch" IRA provision: Pretty good. "There's no 'save the stretch' lobby," Levine said. (Another reason: The budget proposal estimates that by implementing the change, it could collect almost an additional $5.5 billion dollars over the next decade.)

What advisors are saying: If you're concerned that this provision may affect your estate planning strategy, one option is to make your spouse the beneficiary for retirement plans, since spouses would not be affected by this proposal. Then consider other tax-beneficial vehicles for leaving money to kids and other heirs, such as setting up charitable trusts, taking money out of retirement accounts and purchasing life insurance, or gifting money to loved ones before your death.

For more information on other provisions that could affect you, click here.