By Tom Breiter, Integra Capital Advisors
The SECURE Act (which stands for Setting Every Community Up for Retirement Enhancement) has made changes to regulations related to qualified retirement plans like 401Ks, Individual Retirement Accounts (IRAs) and more. Some of these changes are positive, such as allowing smaller employers to band together in providing 401K plans to their employees at lower cost and allowing IRA & 401K owners more control over distributions by postponing the age for Required Minimum Distributions (RMDs) to begin at age 72 rather than at age 70 1/2.
Negatives include elimination of the “stretch IRA” concept where a non-spouse inheritor of an IRA or 401K could start taking RMD’s right away, but base these on their own life expectancy. This usually involved adult children inheriting an IRA when the second of their parents passed away. If the IRA was sizable, it could then become a lifetime asset of the inheritor and conceivably passed to one of their children, potentially providing income for generations to come. No more though. Please note that those who inherited IRAs prior to 2020 are still eligible to use the old stretch distribution concept.
The SECURE Act now requires anyone inheriting an IRA in 2020 or after and not defined as an “eligible designated beneficiary” (EDB) to distribute the entire amount of the inherited IRA within 10 years. It is your choice whether to take annual or periodic distributions or to wait until the tenth year and distribute the entire IRA. This includes IRA trusts are set up to hold IRAs and distributed funds for eventual distribution to individual recipients.
Penalties are steep for not following these rules and IRA inheritors should work with their financial advisor and tax professional to determine the best method to take the required distributions. It may sound like a good idea to let the inherited IRA grow for ten years and then fully distribute the assets, but that would be a larger distribution all in one year, possibly pushing you into a higher tax bracket. It may be more effective, depending on your tax situation, to take smaller, periodic distributions over time to avoid a large tax hit.
EDB’s include spouses, minor children up to the age of majority and some other designations for disabled or chronically ill individuals. These persons follow the old RMD rules based on their own ages. For minor children, regular RMDs are required until the age of majority is reached, then the 10 year window for full distribution of IRA assets begins. This means that in most cases children, grandchildren, siblings, cousins, etc who inherit an IRA in 2020 or later are not EDBs and are subject to the 10 year distribution rule.
Importantly, spousal beneficiaries are EDBs and are always allowed to take the IRA or other retirement account as their own and follow normal RMD rules based on their own life expectancy. This is not considered an inherited IRA and is not subject to the 10 year distribution rule.
Those who inherited an IRA pre-2020 are grandfathered in and may continue to “stretch” the IRA over their lifetime. However, when these grandfathered IRA owner passes, the 10 year rule applies to their inheritors.
Roth IRA’s don’t have any RMD requirement for the original owner under either the old regulations or the new SECRUE Act rules. Curiously, even though Roth IRA distributions are not taxed to either the original owner or the inheritor, RMD’s still apply both pre and post-SECURE Act.
While the SECURE Act is intended to promote active retirement savings and planning for those approaching retirement, it is obvious the underlying intent of the elimination of the “stretch” concept is to provide a boost in tax revenue to the government as trillions of dollars in retirement plan assets are forced out of those plans faster by the 10-year distribution rule rather than the old RMD rules.
Retirement plan, IRA owners and inheritors should consult with their financial and tax professionals on the right strategy for distributions to minimize taxes and maximize benefits.
You can read more about the SECURE Act on many websites. I suggest MarketWatch as a good source of information. Click Here to go to their article on the impact of the new legislation.