The SECURE Act has changed the way beneficiaries inherit money from IRAs.
If you’re a beneficiary or are trying to set up your beneficiary for success, what does this change mean for you?
Today, we’ll break down the new changes to inherited IRAs and highlight what will happen if you fail to plan around the new rules. Plus, learn what you can do to start planning for these changes today!
How the SECURE Act Has Changed Inherited IRAs
A lot of people might not be aware of the recent change to inherited IRAs — or truly understand how the change is going to impact them. While the new rules won’t necessarily affect everybody, for those who have IRAs that will eventually be transferred to their children or non-spouse, there could be a lot of taxes due. This is something we think you should know about and plan around, earlier rather than later.
Before the changes to the SECURE Act were made, most non-spouse beneficiaries who inherited an IRA or 401(k) could choose to withdraw funds by taking required minimum distributions over their entire lifetime. This is often referred to as a “stretch” IRA. This means that if someone who is relatively young inherited an IRA, they only had to take out a small amount and could leave the rest of it to grow tax-deferred as they stretch out distributions over the span of their lifetime.
However, this is no longer the case.
Now, descendants of anyone who dies (or has died) after January 1st, 2020 will have to take their inheritance and deplete the account by the end of the 10th year (with a few exceptions). These beneficiaries have the choice to wait ten years and take it out all at once, or they can take out a little bit each year. However, beneficiaries can no longer stretch distributions out over their entire lifetime.
Exceptions to the Rules
There are three exceptions to this 10-year distribution role. Those who are exempted are:
Minors, until they become of age
Those who are less than 10 years younger than the original account holder
Those who are disabled or chronically ill
Alternative Planning Strategies
For those who are worried about these changes and concerned about the transfer of wealth to their heirs, here are three alternative strategies that can imitate the power of a “stretch” IRA.
A Roth Conversion
A Roth Conversion is when you convert or transfer retirement funds from either a 401(k) or traditional IRA plan into a Roth account. However, once you convert it into a Roth IRA, you will need to pay taxes on your conversion. That’s why you should be careful and see what tax bracket you’re in before converting. However, if beneficiaries wait at least five years after the conversion to begin withdrawing funds, the distributions will then be tax-free.
After converting, and as the money is growing tax-free, it’s crucial to remember that your children will still have to take it out within ten years. But this time, they’ll be able to withdraw without paying taxes on distributions.
With this strategy, you're pre-paying taxes for your children or beneficiary. As we mentioned before, you'll want to see what tax bracket you're in before doing a conversion. If you are in a low tax bracket, a Roth conversion will be very beneficial.
At Heller Wealth Management, we are always ready to help. We can run the numbers and play this out to show you what the gains could be like over your lifetime — and what the additional money going to your children could be.
Charitable giving typically occurs through a charitable remainder trust (CRT). A CRT is an irrevocable trust that is designed to generate a potential income stream for you as the donor or for other beneficiaries for up to 20 years. Afterward, the remaining assets are distributed to the charity of your choice.
There is a cost to set up and administer this type of trust, so this option is not always ideal for everybody. However, it is something to consider if you want to spread the payment out longer than 10 years.
Life insurance is a great option that will provide significant funding while decreasing your tax burden. With this strategy, you would take money out of your IRA, pay taxes on it, and then the remaining balance would pay for a life insurance policy. The life insurance policy could be in a trust, which means that when your children inherit it, they could inherit it tax-free — and estate tax-free.
To end off, there is one last thing we would like to address.
We've seen many people who have named their trust as a beneficiary. But when you name a trust as a beneficiary, sometimes the trust says you're only allowed to take out minimum required distributions. Why? Because this was done before the change in the tax law.
If this is the case for your trust, when you pass away, that trust takes out only minimum distributions for 10 years and then has to take out the entire lump sum in year 10. If you have a trust as a beneficiary, you need to revisit this trust, revisit the beneficiaries, and make the according changes.
When doing so, be sure to seek professional help. Everybody’s situation is unique, and the strategies you use should be optimized to your needs. If you need help assessing the best options for your IRA beneficiaries, please feel free to reach out!Discover exciting new episodes on our Retire Right Podcast and feel free to reach out through our contact page.