Understanding the SECURE Act
In previous posts, "Important Change Affects Special Needs Planning: Stretch IRAs Eliminated." and "Time to Check-Up on your Estate Plan if it Includes IRAs" we have covered certain implications of the recent SECURE Act. In this post we cover the most simple benefits and tax disadvantages and encourage you to discuss further with your financial planner and estate planning attorney.
Benefits Owners of IRAs and Other Retirement Accounts
On December 20, 2019, the United States Congress passed the Setting Every Community Up for Retirement Enhancement Act (SECURE Act). The SECURE Act provides benefits to owners of IRAs and other retirement accounts. Most importantly, the age at which individuals must begin taking required minimum distributions from their accounts was raised from 70½ to 72. In addition, it allows working individuals to continue making contributions to their IRA account regardless of age. Prior to the SECURE Act, if you were 70½ or older, you were no longer able to contribute to your IRA.
SECURE Act Has Negative Impacts for Inherited IRAs
While the SECURE Act benefits retirement account owners, it negatively impacts those who inherit IRAs or other retirement accounts. Previously, individuals who were named as death beneficiaries of retirement accounts had the ability to make only minimum withdrawals over the course of their remaining life expectancy. This was referred to by financial professionals as the “stretch IRA.” Taking advantage of the stretch limited a beneficiary’s tax liability because funds withdrawn from retirement accounts are taxed at ordinary income rates. Taking smaller distributions over many years was much more tax efficient than taking large distributions over a short period of time. In addition, any amounts not withdrawn from inherited retirement accounts continued to earn income on a tax-deferred basis. Accordingly, by taking advantage of these rules, an individual who inherited a retirement account was generally able to receive much more money over the course of his or her lifetime than the value of the account at the owner’s death. In addition, these advantages were available to the beneficiaries of certain trusts that were specifically drafted to be the recipient of retirement accounts at the account owner’s death.
Higher Taxes for Inherited IRAs because of SECURE Act
Under the SECURE Act, most individuals who inherit IRAs or other retirement accounts are now required to withdraw the entire balance of the account within 10 years of the owner’s death. This obviously places a significant tax burden on the beneficiaries of retirement accounts who will be forced to make large withdrawals over a short period of time. For example, someone who inherits a $300,000 IRA account and withdraws $30,000 each year for 10 years will be placed into a higher tax bracket and incur a substantial tax liability.
Spouses Inheriting IRAs Exempted from 10-Year Rule
An important exception to the new 10-year rule applies to the account owner’s surviving spouse. A spouse who inherits a retirement account is still able to take distributions over his or her remaining life expectancy. However, a surviving spouse also has the ability to transfer an inherited retirement account into his or her own IRA on a tax-free basis. This is generally the best option for the spouse.
Is it Time to Convert Your Traditional IRAs into Roth IRAs?
As a result of the SECURE Act, persons with large retirement accounts are advised to consult their financial advisor to discuss ways to minimize the tax burdens for their children or other retirement account beneficiaries. It may be advisable to consider converting traditional IRA accounts into Roth IRAs. An individual in good health, may consider using distributions from retirement accounts to fund life insurance policies to benefit their children. Any bequests made to charities should be funded from retirement accounts because the charity can receive the funds on a tax-free basis. Of course, any actions should be undertaken with the advice of an experienced estate planning attorney.
Estate Planning Attorney in Avon Lake
At Joseph L. Motta, elder law and estate planning firm in Avon Lake, OH, it's our goal to help you leave a legacy, not a predicament. Let us help you look over your estate planning documents to see if they may need updating. Please call our office at 440-930-2826 if you would like to learn more about how the SECURE Act may affect you and your family to schedule a free consultation .