James Zahansky, AWMA®
Principal/Managing Partner, Investment Advisor & Chief Goals Strategist
In 2020 the Setting Every Community Up for Retirement Enhancement (SECURE) Act changed some key rules regarding distributions for those who inherit funds from an individual retirement account (IRA). Now the Securing a Strong Retirement Act, often referred to as SECURE 2.0, is widely expected to be passed in the coming months.
If passed, SECURE 2.0 could bring additional changes to consider for both those who want to leave retirement assets to loved ones and those who have recently inherited them or stand to inherit them in the future. Here’s what to know in order to plan well for how to best put those funds to work for you and your heirs, and how to avoid unnecessary tax consequences if you’ve inherited retirement funds this year.
The SECURE Act significantly shortened the required minimum distribution (RMD) period for non-spouse heirs, leading to a potential large tax liability.
For retirement assets inherited before 2020, a non-spouse beneficiary had to begin required minimum distributions (RMDs), or payouts from the account, within a certain time frame after inheriting it. However, annual distributions could be calculated based on the beneficiary's life expectancy. This ability to stretch taxable distributions over a lifetime helped reduce the beneficiary's annual tax burden and allowed large IRAs to continue benefiting from potential tax-deferred growth.1
But beginning in January 2020, the SECURE Act now requires most non-spouse beneficiaries to liquidate inherited accounts within 10 years of the owner's death. The only exception to this rule is for those who qualify as “eligible designated beneficiaries” – a spouse, a minor child of the account owner while they are still a minor, beneficiaries who are not more than 10 years younger than the account owner, and disabled or chronically ill individuals.
If you’ve inherited a high-value IRA but do not qualify as an eligible designated beneficiary, it’s important to understand how this shorter 10-year distribution period could result in unanticipated and potentially large tax bills. There are no RMDs during the 10-year period, so beneficiaries can take distributions in any amount and any time frame they choose, provided the assets are completely exhausted at the end of the period. Any funds not liquidated by the 10-year deadline would be subject to a 50% penalty tax.
The beneficiary of a traditional IRA might want to spread the distributions equally over the 10 years in order to manage the annual tax liability. By contrast, the beneficiary of a Roth IRA — which generally provides tax-free distributions — might want to leave the account intact for up to 10 years, allowing it to potentially benefit from tax-free growth for as long as possible.
Spousal beneficiaries can roll over the IRA assets to their own IRAs – and if SECURE 2.0 passes, they could potentially wait longer before having to take RMDs.
Spousal beneficiaries can roll over inherited IRA assets to their own IRAs, or elect to treat a deceased account owner's IRA as their own (presuming the spouse is the sole beneficiary and the IRA trustee allows it). By becoming the account owner, the surviving spouse can make additional contributions, name new beneficiaries, and wait until age 72 to start taking RMDs.2
If SECURE 2.0 passes, the age at which RMDs are required will rise to 73 starting on January 1, 2022, then to 74 on January 1, 2029, and finally to 75 on January 1, 2032. In addition, the penalty for failing to take the RMD would be cut in half, to 25% rather than the current 50% penalty tax – and if the missed RMD is corrected quickly, the penalty could even be reduced to 10%. (It’s important to note that a surviving spouse who becomes the account owner of a Roth IRA is not required to take distributions at all.)
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Beneficiaries can choose to disclaim an inherited retirement account.
This may be appropriate if the initial beneficiary does not need the funds and/or want the tax liability. In this case, the assets may pass to a contingent beneficiary who has greater financial need or may be in a lower tax bracket. A qualified disclaimer statement must be completed within nine months of the date of death.
The SECURE Act may render “pass-through” trusts null and void.
Prior to 2020, individuals with high-value IRAs often used conduit — or "pass-through" — trusts to manage the distribution of inherited IRA assets. The trusts helped protect the assets from creditors and helped ensure that beneficiaries didn't spend down their inheritances too quickly. However, conduit trusts are now subject to the same 10-year liquidation requirements, which may render null and void some of the original reasons the trusts were established.
There are things you can do to plan well in light of the SECURE Act rules and potential additional SECURE 2.0 changes.
Retirement account owners should review their beneficiary designations with their financial or tax professional and consider how the existing SECURE Act rules and potential SECURE 2.0 rules may affect inheritances and taxes. Any strategies that include trusts as beneficiaries should be considered especially carefully. Other strategies that account owners may want to consider include converting traditional IRAs to Roths; bringing life insurance, charitable remainder trusts, or accumulation trusts into the mix; and planning for qualified charitable distributions.3
Ongoing tax code and policy changes are just one of the many reasons why it’s so important to continually review and readjust your financial planning strategy. Ongoing monitoring of policy changes and regular meetings to review how those changes affect our clients’ goals and investments are an integral part of our Plan Well, Invest Well, Live Well strategy.
Presented by Principal/Managing Partner, James Zahansky, AWMA®. Securities and advisory services offered through Commonwealth Financial Network®, Member FINRA/SIPC, a Registered Investment Adviser. These materials were sourced from Broadridge Investor Communications; they are general in nature and do not address your specific situation. For your specific investment needs, please discuss your individual circumstances with your representative. Weiss, Hale & Zahansky Strategic Wealth Advisors does not provide tax or legal advice, and nothing in the accompanying pages should be construed as specific tax or legal advice. 697 Pomfret Street, Pomfret Center, CT 06259, 860-928-2341. http://www.whzwealth.com © 2021 Commonwealth Financial Network®
1 For account owners who died before January 1, 2020, the old rules apply to the initial beneficiary only. Under these rules, a beneficiary also generally had the option to take distributions sooner than required.
2 For an account owner born prior to July 1, 1949, RMDs would start at age 70½.
3 Other trusts are generally subject to RMDs based on the owner's life expectancy if the owner had reached the required beginning date; if the owner died before the required beginning date, the account must be emptied by the end of the fifth year after the owner's death. There are costs and ongoing expenses associated with the creation and maintenance of trusts.