Written by Matt Benson, CFP®
For those of you who spent part of last year turning a room of your house into a place to burn off steam, this article is not what the title implies. At the risk of being fact checked, I feel confident that stretching for the purposes of exercise is still a good idea. This article, instead, is directed at those who have IRA accounts. The SECURE Act, signed into law in December 2019, made widespread changes to make it easier for employers to offer retirement plans to employees through tax credits. The new law also changed some of the rules associated with required distributions to allow retirement plan participants and IRA holders the option to defer taking distributions in order to accumulate more savings. This bill did have a price tag however, and the cost was the stretch IRA concept.
For a spouse taking over an IRA as their own, there is not much of a difference before and after the SECURE Act became law. However, when a non-spouse beneficiary inherited all or a portion of an IRA, they previously had three options. The first was a lump sum distribution of the entire amount. That amount would be added to that individual’s taxable income for the year. To soften the tax hit, the rules allowed for the entire account balance to be liquidated by the end of the 5th year after death, conveniently known as the 5-year rule. The last, and often more advantageous option, was the stretch IRA. By taking this option, a non-spouse beneficiary could inherit their portion of decedent’s IRA and they were only required to take a minimal amount out of the IRA each year, essentially stretching the value of the original IRA account over multiple lifetimes. Under the SECURE Act, that last option has been eliminated, effectively speeding up the government’s receipt of the tax revenue that was being prolonged using the stretch concept.
So what does the post-SECURE Act look like related to inheriting IRAs? It essentially made two classes of beneficiaries. “Eligible Designated Beneficiaries” for which the stretch still applies. These are cases like spouses, minor children, or disabled/chronically ill inheritors. The other class is “Designated Beneficiaries,” for purposes of the article, think adult children. For this group, the new rule says that the IRA assets inherited need to be liquidated entirely by the end of the 10th year after death. If a 70-year-old husband and wife have 1 million dollars in their IRAs and have two adult children in their mid-40s think about the impact that could have on future planning. Where previously the stretch would be employed in the event of the IRA owner’s death, now we have two adult children, likely in their peak earning years, required to take significant distributions over a 10-year time frame at their tax rate.
Every planning case has its own unique circumstances. If you have questions about your own situation, please reach out to our team. There may be steps we can take in the near term to address this legislation in your planning. For example, if you think your tax rates may be higher in the future, you may want to consider not delaying your required distributions to age 72. It may be more beneficial to recognize the income at a known tax rate and begin the drawdown of the IRA assets today. You could also essentially pre-pay the taxes for your beneficiaries by doing Roth IRA conversions. There’s no one size fits all solution. If nothing else, this may be a great opportunity to review the types of assets you have and how they will be left to your heirs. Inheriting a taxable asset may not be as big of an issue for one of your beneficiaries as another. Give us a call and let’s start the conversation to see how we can best help you and your family.