So Long, Stretch IRA: The SECURE Act and Your Estate Plan

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So Long, Stretch IRA: The SECURE Act and Your Estate Plan

The Setting Every Community Up for Retirement Enhancement (SECURE) Act, which was passed in December 2019 as part of a larger federal spending package, included changes that warrant special attention from owners of high-value IRAs. Specifically, many nonspouse beneficiaries who inherit IRA assets can no longer "stretch" distributions over their lifetimes.

As a result, IRA owners may want to revisit their estate planning strategies to help prevent their heirs from getting hit with higher-than-expected tax bills.

New Rules

Traditional IRA distributions are taxed as ordinary income. Under the old rules, stretching smaller distributions over a beneficiary's life expectancy could help reduce his or her annual and overall tax burden. It also allowed large IRAs to continue benefiting from potential tax-deferred growth, possibly for decades.

As of January 2020, the rules for inherited IRAs (and employer retirement plan funds) changed dramatically for most nonspouse beneficiaries. Now they are required to liquidate inherited accounts within 10 years of the account owner's death, which could result in larger tax obligations. (For account owners who died on or prior to December 31, 2019, the old rules apply to the initial beneficiary only.)

Wealth-Building Opportunity

In mid-2019, $9.7 trillion was held in IRAs, accounting for about 11% of U.S. household financial assets. The ability and incentive to save for retirement often increase with income, as does the rate of IRA ownership.

Source: Investment Company Institute, 2019

A Hypothetical Example

Margaret, a single, 52-year-old corporate executive, inherited a million-dollar IRA from her 85-year-old father. Under the old rules, Margaret had to begin taking required minimum distributions (RMDs) by December 31 of the year following her father's death. She was able to take RMDs based on her life expectancy of 32.3 years. Upon Margaret's death at age 70, the remaining assets passed to her 40-year-old son, who then continued taking distributions over the remaining 13.3 years of Margaret's life expectancy.

Under the new rules, Margaret would have to empty the account, in whatever withdrawal amounts she chooses, within 10 years. Since she stands to earn her peak salaries during the decade leading up to her retirement, the distributions could push her into the highest tax bracket at both the federal and state levels. Because the account funds would be depleted after 10 years, they would not eventually pass to her son, and her tax bills would be much higher than she anticipated.

Notable Exceptions

The new rule affects most nonspouse designated beneficiaries, especially children and grandchildren. However, there are key exceptions for those now known as "eligible designated beneficiaries" — a surviving spouse or minor child of the account owner; those who are not more than 10 years younger than the decedent (such as a close-in-age sibling or other relative); and disabled and chronically ill individuals, as defined by the IRS. Note that the 10-year distribution rule will apply when a minor child beneficiary reaches the age of majority (18 in most states) or when a successor beneficiary inherits retirement funds after the death of the initial beneficiary.

Trouble with Trusts

In the past, individuals with high-value IRAs have often used what are known as conduit — or "pass-through" — trusts to manage the distribution of inherited IRA assets. The trusts helped protect the assets from creditors and helped ensure that beneficiaries didn't spend down their inheritances too quickly. However, conduit trusts are now subject to the same 10-year liquidation requirements, so the new rules may render null and void some of the original reasons the trusts were established.

Retirement account owners should review their beneficiary designations with their financial or tax professional and consider how the new rules may affect inheritances and taxes. Any strategies that include trusts as beneficiaries should be considered especially carefully.

There are costs and ongoing expenses associated with the creation and maintenance of trusts.



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