How Inherited IRAs Have Changed Due To The SECURE Act

Once lauded as a method for leaving sizable and flexible income to beneficiaries, inherited IRAs have become increasingly more complex after the passing of the SECURE Act. While the bill has implemented many important changes for retirees extending their lifetime savings, this change with inherited IRAs have left many people scrambling to update their estate plans. 

Our goal is to help you craft a meaningful and fulfilling legacy and one way to do that is through your estate plan. If you were relying on an inherited IRA as a big portion of your estate planning strategy, let’s take a closer look at how the rules have changed and other methods to consider.

The new outlook for Inherited IRAs

Prior to the SECURE Act, a beneficiary of an inherited IRA could stretch distributions over the course of their lifetime. This “stretch” provision was particularly helpful with a highly-funded IRA as it allowed the beneficiary to control their tax bill while also accumulating additional funds in the account throughout their lifetime. 

But the “stretch” provision has since been eliminated. The SECURE Act stipulates that beneficiaries must withdraw all of the funds in their inherited IRA by the 10th year after the account owner’s death. There is not a set distribution schedule. You can withdraw the money as often or as little as you like so long as the account is empty within 10 years. 

This rule applies to inherited accounts whose account owner passed away after December 31, 2019. For inherited accounts before this date, the “stretch” provision can still be used. 

Eliminating the “stretch” can present some important tax consequences especially for beneficiaries in their prime earning years. 

With a sizeable inheritance, the tax requirements will now vary drastically if you were able to stretch distributions across your lifetime as opposed to only having a decade to withdraw all of the funds. Since distributions are taxed as ordinary income, it could bump some people into higher tax brackets, increasing their taxable income even more.

If inherited IRAs are a significant portion of your estate plan, be sure to set up a time to talk with your financial advisor and estate planning attorney, as they will be able to help you navigate your unique situation. 

Exceptions to the 10-year rule

As with every rule, there are always numerous exceptions. The 10-year rule is no different as there are a few exceptions. If you are a

• Spouse. Spouses can treat inherited IRAs as their own and do not have to adhere to the 10-year distribution rule. For a traditional IRA, distributions must begin at 72, but a Roth IRA doesn’t carry this same restriction, giving you more options.
• Minor. For minor children who inherit an IRA, distributions will need to be made but those distributions are based on a life expectancy. It is important to note that this exception only applies until you reach your “age of majority” which for most states is 18, at which point you will have 10 years to empty the account.
• A person with a disability. The “stretch” provision will apply to you over your lifetime
• A person with a chronic illness. You are also able to make use of the “stretch” provision
• A person not more than 10 years younger than the account owner. You may also stretch your distributions over the course of your lifetime. 

Unique rules for spouses

Selecting the right beneficiaries is an important part of your estate planning journey. When you select beneficiaries for your specific accounts it is important to know how that selection will impact them. Inherited IRAs have a few characteristics that are important to know for different types of beneficiaries. 

When a spouse is the sole beneficiary of an inherited IRA, they are able to take over the account with greater ease and simplicity. In essence, the IRS views this account as belonging to the spouse the whole time. The surviving spouse is able to do this by designating themselves the owner of the inherited account, roll over the funds from the inherited IRA to a pre-existing IRA, or set up a new IRA entirely.

Spouses have the most flexibility in handling an inherited IRA, but things get a little bit more complex for non-spouses or spouses who aren’t the sole beneficiary. 

Non-spouse beneficiaries 

For all other beneficiaries, including spouses who aren’t the sole beneficiary, the IRS stipulates that you must transfer your assets into a new, specifically designated inherited IRA. You are unable to make additional contributions to this type of IRA, only distributions. 

What about a Roth?

If you are the beneficiary of a Roth IRA, you are able to withdraw contributions tax-free. The tax benefits of Roth IRAs still apply to beneficiaries as long as the account has been open for at least 5 years before the account owner passed away. If the account is younger than 5 years, all distributions will be taxed as ordinary income. 

Legacy Wealth can help

Estate planning is an important, emotional, and complex process. Our team at Legacy Wealth is passionate about helping you and your family create an estate plan that is true to who you are but more importantly helps you live your legacy each and every day. 

Inheritances are a wonderful opportunity to continue a legacy and we want to help you make the most of that. If you would like to talk more about how an inherited IRA could impact your estate plan, schedule a 15-minute call with us. We can’t wait to serve you.