Passing Your IRA to Your Heirs After the SECURE Act

In December 2019, Congress passed the Setting Every Community Up for Retirement Enhancement (SECURE) Act, with the intention of facilitating the creation and use of retirement accounts, including individual retirement accounts (IRAs) and 401(k) plans. Whether intentional or not, the bill has eliminated a popular tool used in estate planning known as the “stretch IRA,” which allowed people to convey an IRA to their heirs while minimizing tax liability. Some options may still be available, though, and our Los Angeles tax advisors can explain them.

What Was a Stretch IRA?

A stretch IRA was a way of passing both the value of a retirement account and its tax deferrals from generation to generation. The term does not describe a type of account, but rather a strategy used to maximize the returns on a retirement account passed down through a will with a minimal tax bill. It was most commonly used with traditional IRAs, which defer income taxes on contributions until the money is distributed to the owner or other beneficiary.

Under new rules found in the SECURE Act, owners of traditional IRAs must begin taking required minimum distributions (RMDs) by a certain date. The amount of the RMD is based on the account owner’s life expectancy, using IRS tables. The remaining balance of the account is divided by the number of years left in the owner’s life expectancy.

Account owners can designate beneficiaries besides themselves or their spouse. Those beneficiaries must also take RMDs, but they could calculate their RMDs based on their own life expectancy, not the account owner’s. This allowed beneficiaries to make the smallest RMD possible. Account owners might leave an IRA to their youngest family member, stretching the life of the account as long as possible.

What Did the SECURE Act Do?

Section 401 of the SECURE Act amended the Internal Revenue Code to require the full distribution of a retirement account within ten years of the owner’s death. While a stretch IRA could keep the account going almost indefinitely, the new law sets a firm deadline for closing it out and paying all of the taxes owed.

What Happens Now?

It appears that the stretch IRA, as an estate planning tool, is no more. IRA owners may still have other options for conveying a retirement account, or the value of what is in that account, to their heirs while managing the tax bill. For example:

1. Convert It to a Roth IRA

Converting a traditional IRA to a Roth IRA spares the beneficiary from the tax bill by making the account owner responsible for it. The converted account will still be subject to the SECURE Act’s ten-year distribution rule, but the distributions will be tax-free. Assuming that the account will grow in value over those ten years, the tax bill now is also likely to be lower than the future tax bill.

2. Give Some to Charity

IRA owners can make qualified charitable distributions (QCDs) of up to $100,000 out of their retirement account to charities, tax-free. This reduces the balance of the account, but it also lowers the tax bill that their beneficiaries will receive.

3. Divide and Distribute

Increasing the number of named beneficiaries on an account means less money to each of them, but also a lower tax bill. It also lowers the chance of bumping any of them into a higher tax bracket through RMDs.

If you need assistance with a tax problem, please contact the tax advisors at the Enterprise Consultants Group today online or at (800) 575-9284 to see how we can help you.

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