Many are surprised to discover that the SECURE Act of 2019 accelerated the tax burden for those who would become IRA beneficiaries in 2020 and beyond. It is also upending estate plans for many retirement account owners who plan on leaving these accounts to non-spouse heirs.
The Setting Every Community Up for Retirement Enhancement Act of 2019, otherwise called the SECURE Act, was signed into law on Dec. 20, 2019—just before the pandemic hit. This is a far-reaching piece of legislation, with several significant provisions intended to help individuals better prepare for retirement.
However, there’s one major downside to the new law. That’s the elimination of the Stretch IRA for most non-spouse inheritors. As a result of the SECURE Act, most non-spouses inheriting IRAs are required to take distributions that empty the account within 10 years after the original owner’s death. This rule applies to traditional and Roth IRAs—even though distributions from a Roth IRA are not taxable. It even applies to 401(k)s and other defined contribution accounts.
Previously, the Stretch IRA allowed the inheritor to extend distributions over their lifetime, with RMDs calculated using life expectancy tables. In essence, the Stretch IRA was a valuable wealth-building tool that is no longer available to many recent, and future, beneficiaries.
Some Inheritors Are Spared
The IRS created a narrow list of eligible designated beneficiaries who can still use the Stretch IRA and take distributions based on their life expectancy:
- A surviving spouse.
- A minor child of the deceased IRA owner. Though, take note, when the child reaches majority age as determined by their state of residence, the 10-year window takes effect.
- A disabled or chronically ill beneficiary.
- A beneficiary who is not more than 10 years younger than the deceased IRA owner.
It’s important to always check with a tax or financial advisor to confirm whether a designated beneficiary is eligible for these exceptions. Penalties are high for noncompliance with distribution rules. Someone who fails to distribute the IRA on time faces a penalty of 50% of the amount that was supposed to be withdrawn but was not. Under current law, 2020 and beyond IRA inheritors who are not considered an eligible designated beneficiary must fully distribute the account.
Does Inheriting My Mother or Father’s IRA Mean That I Have to Pay More Taxes under the Current Rules?
We’ve been hearing this question quite a bit. Distributing an inherited IRA balance over 10 years, versus over your lifetime, will accelerate your receipt of taxable income. In situations where someone inherits a large traditional IRA, distributions from that inherited IRA could very easily push the beneficiary into one or more higher tax brackets, depending on the strategy in place to empty the account.
If you’ve inherited an IRA since January 1, 2020, you may want to consider working with a trusted financial advisor to help guide you in planning the most tax-efficient way to take yearly distributions from the account during the 10-year window so that you maximize the potential value of the gift received.
What if you recently inherited or are about to inherit a traditional IRA and don’t qualify to keep the Stretch? You’ll need to carefully plan how to take distributions over the 10-year window so that you’re not unnecessarily pushed into higher tax brackets from the extra income.
Estate Planning Considerations
What if you’re a traditional IRA owner planning to leave the account to someone other than your spouse? Roth conversions and distributions to qualified charities are among the various strategies worth exploring. As always, it’s important to work closely with your financial advisor to determine your income needs from the traditional IRA.
Everyone’s Situation Is Unique
To maximize the value of an inherited IRA, consider working closely with a trusted financial professional to identify the best strategies for your personal situation.
Investment Advisory Services offered through Midwest Professional Planners, Ltd. (“MPPL”), 2610 Stewart Ave., Ste. 100, Wausau, WI 54401, 1-800-236-6775, an SEC-registered investment advisor. Certain representatives of MPPL are also registered representatives of, and offer securities products involving commission or transaction based fees through APW Capital, Inc., 100 Enterprise Drive, Suite 504, Rockaway, NJ 07866, 1-800-637-3211. Member FINRA/SIPC/MSRB. MPPL is independent of APW Capital, Inc. Registration with the SEC or State Regulatory Authority does not imply a certain level of skill or expertise.