The SECURE Act was passed in 2019, and it had a big impact on the U.S. retirement landscape. Changes ranged from expanding workplace retirement plans for employees to changing required minimum distributions and much more. It also created some confusion as to how it affected stretch IRAs, and how and when beneficiaries were supposed to handle distributions.
In this article, we will look at how the SECURE Act affects inherited IRAs as well as other inherited qualified accounts — and some things to keep in mind about these changes in your retirement planning as well as estate planning.
What Is the SECURE Act?
The SECURE Act (Setting Every Community Up for Retirement Enhancement) was signed into law in December of 2019. Its goal was to increase access among all of the public to tax-advantaged retirement accounts and to prevent people from outliving their retirement assets.
These are the main parts of the bill:
- Provides tax credits to small business owners so that employees of said businesses can contribute to 401(k) plans.
- Long-term part-time employees are now eligible to contribute to 401(k) plans. Under the new law, anyone who works at least 500 hours in a twelve-month period for three consecutive years is eligible.
- No more age limits for IRA contributions. You used to be able to contribute to your IRA only up to age 70.5, but now you can continue making contributions indefinitely.
- The age at which people needed to start required minimum distributions was pushed from 70.5 to 72.
- Inherited IRA and qualified retirement plan distributions (i.e., retirement accounts with pre-tax money) must be taken within ten years.
The last point could have major implications for owners of inherited IRAs, so let’s take a closer look.
How Did the SECURE Act Affect Inherited Retirement Accounts?
Before the SECURE Act, someone who inherited an IRA could take the taxable distributions over the course of rest of their lifetimes (see the IRS life expectancy tables). If someone inherited an IRA, they had a few options:
- Cash out the account, which is almost always a bad idea. That money would count as income for the year, which would put you in a higher tax bracket and greatly increase income taxes owed.
- Take the least amount possible (required minimum distribution), and leave the rest of the account alone, where it could grow in value with tax advantage for many years. This was known as a “stretch IRA” because the payments would be stretched out over a lifetime.
The SECURE Act did away with stretch IRAs for the most part, with some notable exceptions. Now, generally speaking, those who inherit an IRA must take money from the account within ten years, whether in one distribution or a series of distributions.
Talk to your financial professional and tax advisor for personal guidance if this applies to you. The IRS has put out some guidelines on these distributions that can be tricky to navigate on your own.
Who Can Still Use Stretch IRAs Under the SECURE Act?
Exceptions to this 10-yr account distribution rule under the SECURE Act include:
- Beneficiaries who are a spouse of the original account owner
- Minor child or children of the original owner
- Anyone less than ten years younger than the original owner
- Someone disabled or chronically ill
If a minor child inherits an IRA, they can take required minimum distributions up until the age of majority or until they finish school, up to the age of 26. Then they must close the account within ten years, just like everyone else.
The SECURE Act’s definition of a disabled or chronically ill person is close to the same standards that qualify someone for public assistance. According to the IRS, a person is permanently and totally disabled if they can’t engage in any substantial gainful activity because of a physical or mental condition, and the condition is expected to last at least a year.
If you inherit a Roth IRA, the ten-year rule still applies. The entire Roth IRA must be distributed within that 10-yr window, but those withdrawals will generally be tax-free for the beneficiary.
How to Handle Distributions from Inherited Accounts
The important thing to consider is how the distribution of the inherited IRA will affect how much you pay in taxes.
If you divide it up into a series of distributions, you may be in a higher tax bracket because each distribution will count as income. You may also want to talk to your financial advisor and tax advisor about the IRS treatment of these distributions, as some IRS guidance material that is pretty technical has come out regarding them.
Should you take the IRA as one lump-sum payment, you will most likely pay more in taxes the year that you cash it in because all of that money will count as income. This is why it’s almost never a good idea to cash out any retirement account.
If you inherit an IRA from your spouse, you can roll over the inherited IRA into a retirement account under your own name. It will be subject to the rules of any other retirement account, meaning a 10% penalty if you try to access it before you turn 59.5, and you will need to start RMDs once you reach 72.
What to Discuss with Your Financial Advisor
Most people will want to pay as little in taxes as possible. That is why complex matters such as these are best discussed with a financial advisor. Make sure you consult with someone before you decide what to do with your inherited IRA.
Another important thing to discuss is how to make sure your money lasts your entire life. When you meet with your financial professional, have a record of your annual spending, so that they can estimate how much you will need in retirement. Also, discuss if you intend to leave behind a nest egg for your children, grandchildren, or favorite charities when you pass on.
Financial advisors can help you zero in on your goals, pay less in taxes, and make sure you enjoy your retirement years.
Are you looking for a financial professional to help you sort through your financial “what-ifs” and put a plan in place for your future? Or perhaps you want a second opinion of your current plan. No sweat, many independent financial professionals are available at SafeMoney.com to assist you.
Use our “Find a Financial Professional” section to get started and connect with someone directly. Please feel free to discuss your situation and, if need be, request an initial appointment to explore a potential working relationship. Should you want a personal referral, please call us at 877.476.9723.