The SECURE Act (“Setting Every Community Up for Retirement Enhancement” Act), which was enacted in December 2019, eliminated the “stretch IRA” – a feature of an inherited IRA account[1] that allowed the beneficiary to stretch out required minimum distributions (RMDs) over his or her lifetime, thereby deferring a significant amount of income taxes on the RMDs. Now, beneficiaries must withdraw the entire account over the 10-year period following the owner’s death. Doing so will significantly accelerate the income tax due with respect to the account.
Perhaps you are thinking: this is a piece of legislation coming from Washington – there’s got to be a loophole, right? The answer is: maybe. Here are a few planning ideas to consider in light of the SECURE Act:
- Increase the number of designated beneficiaries.
- If an IRA account is divided among five beneficiaries instead of two, for example, the amount that each beneficiary receives, and therefore must pay tax on, is less. Of course, this works best in large families where there are more people who may be named as beneficiaries.
- Designate beneficiaries who are in a lower tax bracket.
- If you have one child who is wealthy and another child who is not, you could designate the less wealthy child as the beneficiary of your IRA account and the wealthier one as the beneficiary of another asset. The income tax liability may be less burdensome to your child who is less well-off and in a lower tax bracket. But beware: this type of estate planning requires frequent review if your goal is to ensure that your children are treated equally. If you spend down your brokerage account during your lifetime but don’t touch the IRA, for example, then what seemed like an equal distribution when you enacted the plan will be very unequal when it is implemented after death.
- Take advantage of a Roth conversion during your lifetime.
- If you are in a lower tax bracket than your designated beneficiaries, you could convert your traditional IRA into a Roth IRA. Doing so will have an immediate income tax consequence to you, but will greatly benefit your beneficiaries because distributions from a Roth IRA are not taxable.
- Designate “eligible beneficiaries” who can still continue to stretch RMDs.
- The SECURE Act allows “eligible beneficiaries” to stretch RMDs over their lifetimes. These include spouses, minor children, and chronically ill or disabled persons. But beware, the 10-year rule comes into play once minor children become adults, and an RMD in the hands of a disabled beneficiary could jeopardize eligibility for government benefits.
- Spend down IRAs, save other assets.
- For example, consider using your RMDs to make charitable contributions during your lifetime rather than making donations from other assets; the maximum amount allowed per year is $100,000.
- Utilize charitable remainder trusts.
- Leaving your retirement accounts to a charitable remainder unitrust (CRUT) or charitable remainder annuity trust (CRAT) allows your relatives or friends, as the income beneficiaries of the trust, to receive distributions from the trust that the trustee withdraws from the IRA over the course of their lifetimes (or a specified time period), instead of taking the IRA distributions over the 10-year period required under the SECURE Act. Whatever is left upon their death (or at the end of the specified term of years) must pass to charity, so this approach works best if you are already charitably inclined.
Planning opportunities may also exist for the beneficiaries of an inherited IRA under the SECURE Act. Notably, the law does not require equal distributions over the 10-year period, but only that the entire account be withdrawn during that time. This means a beneficiary could withdraw the entire account in one year to pay for a large expense, such as a home renovation project or college tuition (just remember that the distribution is taxable), or spread it out over some or all ten of the years to likewise spread out the income tax liability.
We recommend that you talk to your estate planning attorney, accountant or financial planner about whether any of these planning ideas regarding retirement accounts may benefit you and your family.
[1] For purposes of this article, “IRA account” refers to all types of retirement accounts, including Individual Retirement Accounts, 401(k) plans, 403(b) plans, and the like.