Have you named someone other than your spouse as the beneficiary of your IRA or 401(k)?
If so, this article directly applies to you!
Among other things, the SECURE Act that went into effect on January 1, 2020 affects how non-spouse beneficiaries will inherit IRAs.
Under current law, non-spouse beneficiaries of an IRA or defined contribution plan such as a 401(k) must take required minimum distributions (“RMDs”), but could extend the withdrawals over his/her lifetime (rather than the original owner’s lifetime) to minimize the tax hit.
Such a strategy is referred to as a “Stretch IRA” because the RMDs in some cases could be stretched out for decades, allowing the funds to continue growing tax-deferred.
Practically speaking, the “Stretch IRA” provisions meant that the amount of the RMD, and thus, the beneficiary’s tax bill, was lower.
However, the SECURE Act changes all of that.
Under the new rules, aptly called the “Drain-in-10 Rule,” certain beneficiaries will have to withdraw all funds in an inherited IRA/401(k) within 10 years from the death of the original account owner, and applies to accounts inherited after December 31, 2019.
While there are no RMDs required under this new rule, after the 10th year, any money that is left in an IRA or 401(k) must be taken and the account closed, regardless of the tax consequences.
For many, the new 10-year rule drastically diminishes the chances of a beneficiary withdrawing assets in a tax-friendly manner.
Further, for folks that have setup “conduit” or “pass-through” trusts for their beneficiaries, the new rules could result in the unintended consequence of a beneficiary essentially being locked out of the account for the entire 10-year period.
According to an article published in MarketWatch, “This provision can be especially dangerous for people who are inheriting an IRA through a trust,” said Jamie Hopkins, director of retirement research at wealth management firm Carson Group in Omaha, Neb. “Account holders may have set up a loved one’s inheritance through a “conduit” or “pass through” trust, which would dictate that the beneficiary can only receive the required minimum distribution every year and no more.”
“A trust like this protects the beneficiary from withdrawing too much and wasting the money, and the original owners of the IRA may see a trust as advantageous if the beneficiary is a young adult or a spendthrift.”
“But under the SECURE Act, there are no required minimum distributions for inherited IRAs. . . The only technical required minimum distribution is after the 10th year, which would be the remaining balance. In the case of an inherited IRA through a trust, that would be the entire amount, with no opportunity to take out money during the 10-year wait.”
The SECURE Act also increased the age at which RMDs are mandated to 72 unless a taxpayer was already 70½ or older as of Dec. 31, 2019 – in which case, he or she must start withdrawing funds, as per the old threshold.
There are exceptions, however. The new rule does not apply to spousal beneficiaries, disabled beneficiaries, or beneficiaries no more than 10 years younger than the account holder. (Minor children—not grandchildren-- are also exempt, but only until they reach majority age – 18 in Florida. After that, they will have 10 years to withdraw the assets in an inherited account.)
There are many positive intentions behind the passing of the SECURE Act – including making it easier for small businesses to set up 401(k)s, enabling more part-time employees to opt in to retirement plans, and more; nonetheless, its detrimental effect on estate planning is clear.
If you have a retirement account, we recommend that you consult with your financial/tax advisor to review current beneficiary designations.
Further, if you believe your Estate Plan may be affected, we invite current clients to schedule a quick consultation to review existing Estate Planning documents we have prepared, particularly those plans which include a retirement benefit trust (whether in your Will, your living trust, or a stand-alone retirement trust).
You may schedule your $97 review consultation (existing planning clients only) by clicking here or the button at the end of this post.
Failure to revisit your estate plan now could result in excessive taxes for your beneficiary, or worse, no access to money for 10 years after your death.
Amanda “Keeping You Informed” Lynch Elliott
