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New retirement legislation was signed into effect just before Christmas, on December 20, 2019. Non-spousal beneficiaries of inherited IRAs are now required to withdraw all of their money within 10 years. Previously, non-spousal beneficiaries could opt to take only required minimum distributions over their life expectancy, potentially allowing the funds to grow tax-free for years. This is now not possible, due to the elimination of these “stretched” distributions.
Beginning in 2020, under the new Secure Act, non-spousal beneficiaries of IRAs are required to take the entirety of the funds within 10 years after the death of the initial account owner, and then close their account, regardless of tax consequences. In other words, the only required minimum distribution would be the close out after year 10 of any remaining balance in the account.
The Secure Act also applies to inherited 401K accounts, regardless of whether they are subsequently rolled into IRAs, Roth IRAs, and other defined contribution plans as well. This is unfortunate because it means that some non-spousal beneficiaries may miss out on the tax-deferred growth of an IRA over the course of decades. But, the new 10-year rule impacts only those who die in 2020 and beyond; current beneficiaries who have been taking distributions from an inherited IRA or a 401K for years, are still permitted to withdraw the required minimum distributions over their life expectancy.
What about beneficiaries who have their inheritance set up through a trust, which allows beneficiaries only to receive the required minimum distributions every year? The original owner would typically view a trust of this nature as advantageous to a young or spendthrift beneficiary, to protect the beneficiary from withdrawing excessive amounts. Now, in the case of an inherited IRA through a trust, the entire amount would have to be withdrawn and there would be no ability for distributions during the 10-year period.
There are exceptions to the new Secure Act. Surviving spouses can withdraw just the required minimum over their life expectancy, as well as minors, those with disabilities, and those who are not more than 10 years younger than the account holder (such as a younger brother or sister). The 10-year provision of the Secure Act would not affect a minor child till he or she turns the age of majority, but after that, they would have 10 years to withdraw the assets in an inherited account.
The cost to beneficiaries and account holders who are to inherit IRAs or 401Ks is significant. There are no tax breaks for withdrawing funds from either traditional or inherited IRAs, which means that payments will be taxed at the beneficiaries’ income tax bracket. This very well could result in a large tax bill for a non-spousal beneficiary depending on their tax bracket at the time of receipt. In light of the new Secure Act, beneficiaries and account holders should review their documents about inheriting IRAs or 401Ks. If you have an IRA trust, it should be evaluated as well, to assure the inheritance is not detrimental to your beneficiaries. Failing to do so could result in significant taxes on the assets to your intended beneficiaries, or no ability for your intended beneficiaries to access the money for years. If you are in this circumstance, you should seek counsel from your estate planning lawyer without delay.
The Secure Act could protect and increase retirement savings, especially if you increase your contributions to your IRA. This would allow for you to save longer while taking advantage of tax-deferred growth. Contributions to a traditional IRA can now be made after the age of 70 ½, and the required minimum distribution age is increased from 70 ½ to 72, allowing retirement funds to grow before making those withdrawals. Your estate planning lawyer should also evaluate and advise you on any tax savings in light of these significant legislative changes.