Inherited IRAs Aren’t What They Used To Be
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In December 2019, Congress quickly passed the Setting Every Community Up for Retirement Enhancement Act, more commonly known as the SECURE Act. The SECURE Act is a big deal for many reasons, the first being it was put into effect immediately in January 2020 with little notice. The second reason is that it changed a lot of major tax laws that may affect the distribution of your retirement accounts and your overall estate planning.
As a result of the SECURE Act most inherited IRAs do not have the same tax benefits they had before its passing.
If there is one takeaway from this article, it is that we highly recommend you review the beneficiary designations for your retirement accounts and consider making some changes to any previously established plans.
What is the SECURE Act?
The SECURE Act is a bipartisan bill that is designed to make retirement easier and more accessible for many Americans. Its purpose is to address concerns with elderly populations needing to supplement their Social Security income and the fact that almost half of the American workforce does not participate in a workplace retirement plan.
The two biggest effects of the SECURE Act are on small business owners and their employees, as well as retirement accounts.
Under the SECURE Act, small business owners can set up “safe harbor” retirement plans that are more affordable and easier to set up for their employees. Even part-time employees that meet the eligibility requirements can participate. The bill also encourages 401(k) plans to offer annuities.
The SECURE Act also affects IRAs. The bill pushed forward the age IRA owners are required to take minimum distributions (RMDs) from 70.5 years old to 72 years old. Additionally, traditional IRA owners can continue to make contributions to their accounts indefinitely.
The SECURE Act’s Effect on Inherited IRAs
The SECURE Act changed the benefits of stretching an IRA over a beneficiary’s lifetime. The most notable change was the removal of the required minimum distribution (RMD) provisions. Before the SECURE Act, RMD provisions allowed most beneficiaries to stretch their inherited IRAs for their lifetimes. Under the SECURE Act, in many cases, the entire retirement account must be withdrawn by the beneficiary within 10 years after the death of the owner. There are exceptions, such as if the beneficiary is the owner’s spouse, a minor, under a disability, or chronically ill. Unless the account is a Roth, the distribution will be a taxable distribution. The problem is that for many people, this means withdrawing the account during the highest income tax years of their life.
Converting Your IRA to a Roth
If the tax considerations do not bode well for your current plans, there is always the option to convert your traditional IRA to a Roth. With a Roth IRA, the taxes will already be paid for the beneficiary. The key consideration with converting your plan to a Roth is that you will pay a high-income tax price to fund the new Roth. In some cases, you may want to spread the conversion over a longer period.
Choosing a Charity as an IRA Beneficiary
The SECURE Act gives less incentive to pass your IRA to an individual beneficiary other than your spouse or a disabled descendant. If you are already planning on giving a portion of your assets to charity, your IRA could be a great place to start. You can designate a charitable organization as your beneficiary. The charitable beneficiary does not pay income tax when the IRA is paid to the charity. You may then choose to remove all or some of the charitable giving from your Will. There are also strategies (such as charitable remainder trusts) that allow you to give a portion of your IRA to your children and part to charity. This would limit the potential negative income tax Issues under the SECURE Act.
At Sessa & Dorsey, we advise our clients on properly designating the beneficiaries of their retirement plans to meet their specific needs and desires. If you have questions about retirement planning, please contact us at (443) 589-5600.
