The SECURE Act of 2019 is the largest retirement reform law since the Pension Protection Act of 2006. This sweeping legislation changed many of the rules around retirement savings in America.
One of the more significant changes affects beneficiaries of IRA accounts. The “stretch” provision that allowed IRA beneficiaries to take distributions over their life expectancies was repealed. Now, most beneficiaries who inherit an IRA after 2019 must distribute it within 10 years.
We have received a lot of questions about how this rule works, so here is a review of the key facts.
The Pre-2019 Rules
When a beneficiary inherits an IRA, they are subject to distribution rules that determine when and how much of the IRA must be distributed out (and charged as taxable income to the beneficiary).
Before 2019, designated beneficiaries of an inherited IRA could choose to distribute the IRA annually over their life expectancies, or to distribute the entire IRA within 5 years. Distributing it annually was often beneficial because it allowed the beneficiary to defer most of the tax for many years.
The New Rules
The SECURE Act changed the rules substantially for IRAs (both traditional and Roth) inherited after 2019. The 5-year rule was extended to 10 years so that distributions are optional until the end of year 10 after the IRA owner’s death, when all the balance must be distributed. However, the option for beneficiaries to take distributions annually over their life expectancies was repealed.
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There are several exceptions to the removal of the life expectancy method. The following beneficiaries are still able to distribute an inherited IRA over their life expectancies:
- A surviving spouse
- A minor child (the 10-year rule applies once the minor reaches the age of majority)
- A disabled or chronically ill individual
- An individual who is not more than 10 years younger than the deceased participant or IRA owner
Beneficiaries who are not in one of these categories are subject to the 10-year rule.
What About a Trust as Beneficiary?
Leaving IRA assets to a trust, rather than to individual beneficiaries, may be appealing because a trust can control how and when the assets can be distributed. There can be other benefits too, such as asset protection from creditors and centralized asset management.
Before the SECURE Act, a trust beneficiary could stretch the required distributions over his or her life expectancy if the trust met all the “see-through” requirements.
Now, there is some uncertainty as to whether the “see-through” rules will apply because they were not specifically addressed in the SECURE Act legislation. If they do apply, the IRA assets must be withdrawn within a 10-year period, except under limited circumstances. If the see-through rules do not apply, the IRA assets will need to be withdrawn within a 5-year period.
Implications for Retirement and Estate Planning
There can be sizeable tax ramifications from these changes. Beneficiaries who fail to take RMDs by the applicable deadline will owe the IRS a 50% excess accumulation penalty on any RMD shortfall.
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Even when the distributions are done before the deadline, the timing can have a big impact. Distributing a $1 Million IRA in one lump sum will result in the distribution being taxed in the upper tax brackets, whereas distributing gradually over the ten years can allow for lower tax rates.
When the beneficiary is a trust, the language may force the trustee to distribute the whole balance in year ten rather than gradually, forcing the tax bill way up. Or, in the case of an “Accumulation” trust, the distributions may be taxed at the trust rates, which can get up into the highest brackets much quicker.
If it has been a while since you reviewed your IRA beneficiary designations, it will make sense to look at them again in light of the SECURE Act changes. If you have named a trust as beneficiary, consult with your attorney on how the trust language works with the new rules. There may be changes you can make to the language that will give your heirs a much more favorable result, while honoring your wishes.
At Blankinship & Foster, we help you plan for the future, so you can be confident that your family will be in good financial shape. As part of our Wealth Management service, we review your estate planning and talk with you about decisions you can make to achieve the outcomes you want. Changing rules and laws can be complex, but we help you navigate the changes, so you can have confidence, clarity and direction.