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If you haven’t heard of the Secure Act, you may want to sit down, and don’t worry about stretching first, because you aren’t allowed to "stretch" anymore.
As of January 1, 2020, the Secure Act has drastically changed the way your Qualified Retirement Plans (think IRA and 401k) are treated, especially after you die. For simplicity, I’ll refer to all such plans as IRAs in this little note. And remember, every dollar in your IRA is subject to taxation when withdrawn. Because of this change, us estate planning attorneys, financial advisers, and CPAs will also need to adapt many of the planning strategies we discuss with our clients.
The point of this blog isn’t to assess the Secure Act in detail. It's intended to simplify the big changes for you to then ponder. So don’t worry, you won’t find a boring legal analysis below.
- Good-Bye “Stretch” IRA for non “Eligible Designated Beneficiaries” (EBDs): Before this change, basically any non-spouse beneficiary that inherited your IRA had to, at a minimum, take an annual “Required Minimum Distribution” (RMD) during that beneficiary’s life expectancy. In essence, it was possible for the beneficiary to only take the RMD each year, and the inherited IRA could continue to grow, or be stretched-out decades into the future. This made the IRS grumpy. They weren’t able to collect their taxes quickly enough—the stretch IRA essentially served as the proverbial brake pedal to paying those income taxes.
Now only your surviving spouse, a beneficiary no more than 10 years younger than you, a minor child (not grandchildren), and disabled or chronically ill individuals are the only EBDs. They can still utilize the “stretch” provisions. For non-EBDs, and minor children once they reach the age of majority, there’s a new rule...
- Hello, 10-Year Rule: Now, if the EDB exception doesn’t apply, (which will be more times than not), all inherited IRA funds must be completely withdrawn by the end of the 10th year after the original plan holder’s death; and, RMDs are gone (Roth IRAs didn’t have RMDs, but are still subject to the 10 year rule). So, all of that IRA money you’ve been deferring paying income taxes on (potentially to pass on to children to help them financially for the rest of their lives) must be withdrawn in ten years. Essentially, the has IRS put their other proverbial foot on the inherited IRA income tax gas pedal.
To be clear, the new ten rule doesn’t change the existing rule that states if you don’t have someone named (or they’re no longer alive) as beneficiary on your IRA, then your IRA passes to your estate, and it all must be distributed within five years after death.
- Inherited IRAs and Trusts: Many people have chosen to utilize trusts in their estate plans, and often make their trust the beneficiary of IRAs for a variety of reasons. With a properly drafted trust, there were no negative income tax consequences of passing an IRA to beneficiaries (remember, trusts reach the top tax bracket of 37% once it earns $12,950 of income, where those married filing jointly require $622,050 of income to reach the top bracket—a huge difference).
You can still name your trust as the IRAs beneficiary, as the reasons to do so may likely exist, but many trusts will need to be amended to prevent the IRSs gas pedal from flooring beneficiaries—once they see how much money their trust will owe the IRS.
Here’s the main purpose of this post—you need to Act! Start by:
- ACT #1: Gather all of your IRA account(s) information, and confirm who the beneficiaries are for each account.
- ACT #2: Make sure you have designated beneficiaries, and note any IRA that names a trust as a beneficiary or your estate as beneficiary.
- ACT #3: Gather your trust (or will, if your will creates a trust for someone after your death) and note the beneficiaries listed in your estate planning document. Also check to see if your beneficiary is receiving things (it’s theirs, no restriction), or in trust (usually this provides the beneficiary protection of their inheritance after you die).
- ACT #4: Consider, and make notes of, any circumstances you wish to protect your beneficiary’s inheritance against; like, divorce, poor financial decision making, addiction issues, and special needs or disabilities, etc.
- ACT #5: Discuss the notes you’ve made after reviewing your estate plan and IRA’s with your attorney so that they can identify if anything needs to be amended due to the change in the law.
Please Act! Doing this little exercise will help your attorney, financial adviser, and CPA create the most tax efficient estate plan. If you choose not to, the value of your estate could get wrecked by the IRS’ gas pedal.
You know, I saw a really funny cartoon the other day. A man was sitting at a desk with a couple in front of him. Behind him, a big sign on the wall said “THE IRS.” The couple looked at each other, and one said, “See honey, I told you it was all ‘THEIRS’. It doesn’t have to be...
If you think the Secure Act may impact you, schedule a meeting with one of our attorneys to learn more.
Written by Kyle Allen, Attorney