In December 2019, the United States Congress passed the Setting Every Community Up for Retirement Enhancement (SECURE)Act to make saving for retirement easier and more accessible for Americans.
For the most part, the SECURE Act was good, as it gave people until age 72 to start withdrawing Required Minimum Distributions (RMDs)from their IRA accounts instead of age 70. This has now been extended to age73, and in year 2033 it will move to age 75. However, there’s one rule change thatis easy to skim over but could have a massive tax impact on you or your kids.
Under the old rules, if you inherited an IRA or a 401(k) retirement account, you would have what some referred to as a “stretch IRA” because you could stretch the withdrawal of the money in the account over your lifetime. Unless you inherited a massive IRA, you wouldn’t have much of a tax impact each year because you could break up the withdrawals over several decades, especially if you were younger.
Now, unless you are an Eligible Designated Beneficiary (EDB), you are required to withdraw and pay tax on the entire account in 10 years. Which camp do you fall into, and how do you know if this law affects your financial plan?
First, determine that the person receiving the money is an Eligible Designated Beneficiary. Spouses, beneficiaries with disabilities, people who are chronically ill, and individuals less than 10 years younger than the original IRA owner can continue to use the “stretch IRA” strategy and spread the tax impact over their lifetime. Minor children can as well, although the 10-yearclock kicks in as soon as they turn 18.
Adult children who inherit IRAs from their parents while in their peak earning years may be adversely impacted, more than others, by this rule change. For example, let’s say you are 50 years old and inherit a sizable IRA from a family member who recently passed away. You are probably at or near the height of your career earnings and more than 10 years from retirement.
Because of this provision in the SECURE Act, you now must withdraw the funds from this IRA, which will potentially bump you into a higher tax bracket due to this increased income. However, if you aren’t already contributing the maximum amount into your retirement accounts, you could offset some of the IRA disbursements by increasing your pre-tax contributions to your employer plan or your own IRA account.
If you have a 401(k) and an IRA retirement account, you may want to change your beneficiaries to better fit the 10-year rule. Perhaps you want to leave your IRAs to a church or charity that would pay no tax on the account. Or you could leave funds from a different account and property to your kids, and leave the inherited IRA funds to a sibling less than 10 years younger than you. You could focus on charitable giving while you are alive. You might even decide that it makes sense to do Roth conversions and pay the tax now if your tax rates are lower than for your kids. If your kids inherit a Roth IRA, the 10-year rule still applies, but the dollars are completely tax-free to them.
Like so many topics in the financial planning world, these changes are more complicated than I can fit onto a two-page document, making it especially important to receive professional advice about your personal situation. If you inherit an IRA or any other investment account, review the rules with your financial advisor – they can also coordinate with your tax advisor to determine the appropriate course of action for you. Even if this rule change results in more taxes being paid, be thankful for the dollars you are receiving and the hard work that went into saving and growing them by the person who bequeathed them to you.
Whether this all makes sense to you or your head is spinning, connecting with an experienced financial advisor like a team member from TruStone Wealth Management could result in a difference in the total tax Uncle Sam takes from an inheritance. If you have IRAs or inherit them, make sure you have a plan that works for you!
Timothy Fugleberg
CFP®, APMA®, CRPC®
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