The Setting Every Community Up for Retirement Enhancement Act of 2019 (SECURE Act) eliminates the stretch IRA for most non-spouse beneficiaries, beginning with deaths in 2020.
That means many taxpayers should look at revising their estate plans. Here’s why.
New IRA rules
Prior to the SECURE Act, which was a tax measure signed into law in December 2019, the law allowed heirs to “stretch” IRA distributions over their entire life expectancy. This means you could theoretically leave a large IRA to a grandchild, for example, and the distributions could be spread out over decades. This provided a significant tax deferral benefit for younger heirs.
Alas, it was too good to last: The SECURE Act revokes the stretch IRA for most beneficiaries. Instead, most non-spouse beneficiaries must empty inherited IRAs within 10 years of the original IRA owner’s death.
Exceptions
There are several exceptions to the new 10-Year Rule:
- Surviving spouses;
- The deceased’s children (but not grandchildren) under age 21. The 10-year clock starts when they reach their 21st birthday;
- Disabled beneficiaries;
- Beneficiaries with chronic illnesses;
- Beneficiaries not more than 10 years younger than the original IRA owner; and
- Charitable remainder trusts (see below).
What to do now
- Start Roth conversions. Your heirs can take income from an inherited Roth IRA tax-free, but only if the account is at least five years old at the time of your death. If less than five years elapse before your death, your heirs will need to pay taxes on any earnings within the Roth IRA.
By starting Roth conversions now, you increase the likelihood that your heirs will benefit from the tax advantages of the Roth IRA. You may also reduce your taxable estate. - Review any IRA trusts. Have an attorney look at converting existing conduit trusts to accumulation trusts. These allow distributions to remain within the trust, preserving creditor protection. IRA distributions can remain within an accumulation trust indefinitely.
- Spread the wealth around – using ‘spray trusts.’ A ‘spray trust’ takes your IRA assets and “sprays” the income generated to multiple beneficiaries. You can list all your children and grandchildren as beneficiaries. The more you spread out the distributions, the more tax-efficient the distribution is likely to be.
- Consider leaving life insurance, rather than an IRA. Unlike IRAs, life insurance death benefits pass to beneficiaries entirely tax-free.
- Use charitable remainder trusts. Charitable remainder trusts allow you to stretch inherited IRA income over 20 years, rather than 10. This also helps protect assets from creditors. At the end of 20 years, the remaining assets go to a charity you designate.
SECURE Act benefits
There is some good news: The SECURE Act increased the IRA required minimum distribution age from 70½ to 72. This benefit applies to everyone who had not yet turned age 70½ as of Jan. 1, 2020. This means an additional 18 months of tax-deferred compounding.
The SECURE Act also struck down the prior age cap on new IRA contributions. If you still have earned income after age 70½, you can now keep contributing to traditional IRAs as long as you like.