Estate Planning: Understanding Inherited IRAs and the SECURE Act

With October being Estate Planning Month, we wanted to address IRAs (individual retirement accounts). Until the SECURE Act, IRAs were relatively easy to incorporate into an estate plan. As long as beneficiaries are named after the IRA owner dies, the assets are automatically and easily transferred to the account beneficiaries. Those beneficiaries then had several distribution choices at their disposal to minimize the tax impact of the new account.

However, the SECURE Act eliminated one major distribution option for non-spouse beneficiaries: the ability to stretch distributions out over their own life expectancy. So now, with a few nuanced exceptions, anyone other than a spouse must withdraw the total balance of an inherited IRA within 10 years. With that compressed timeline for any beneficiary besides a spouse (who can still elect to roll the whole IRA into their own and treat it as such for distribution purposes), it makes estate planning for IRAs more complicated.

Impact of the SECURE Act on IRAs

Key Rules for Non-Spouse Beneficiaries

The IRA assets of a decedent must be put into an Inherited IRA for the benefit of a non-spouse beneficiary (like a child, relative, or friend). The inherited IRA assets may not be commingled with the beneficiaries’ other accounts. Generally, the IRA beneficiary must take a required minimum distribution from the account annually (with a few exceptions)—these distributions must start by December 31st of the year following the decedent’s death. The entire Inherited IRA balance must be distributed by the 10th year following the date of death.

Tax Implications of Compressed Distributions

For many beneficiaries, this compressed distribution timeline causes significant tax issues. Inheriting a large IRA of $500,000 usually means required distributions near $50,000 per year. Adding this $50,000 taxable income on top of a beneficiary’s own ordinary income often pushes the beneficiary into higher tax brackets.

Estate Planning Strategies for IRAs

Careful planning before and after inheriting IRA assets can help to minimize taxes. Here are a few estate planning options to consider:

1. Qualified Charitable Distributions (QCDs)

While the IRA owner is alive, using their IRA to make charitable contributions can help to spend the tax-deferred assets and preserve the assets in accounts with fewer tax issues. After the IRA owner dies, the inherited IRA beneficiary can make QCDs directly from the Inherited IRA to a charity, which can reduce taxable income. For more information on QCDs, visit the IRS’s official guide on QCDs.

2. Roth IRA Conversions

Thoughtful planning before death can make a huge impact on the beneficiary tax issues upon inheriting IRA assets. If IRA owners systematically convert a Traditional IRA to a Roth IRA before death, the Roth IRA assets can be withdrawn tax-free by IRA beneficiaries. Taxes on Roth conversions must be paid in the year of conversion, so this strategy requires careful analysis of current tax brackets versus projected tax implications in the future. You can read more about Roth IRA conversions from Fidelity.

3. Beneficiary Designation

Regularly review and update beneficiary designations to ensure they align with tax strategies. With the SECURE Act, naming trusts as IRA beneficiaries became more complicated. Carefully evaluating the trust language to be sure the trust will qualify for the longer 10-year distribution window is critical.

4. Consideration of Timing

Strategically plan distributions. For non-spouse beneficiaries, taking distributions over several years can help manage tax brackets. For some beneficiaries, this may mean taking larger distributions in some years to take advantage of lower bracket years, and not just assuming equal distributions across the 10-year period.

5. Consultation with Professionals

Engage estate planning and tax professionals to create a tailored strategy that meets individual needs and maximizes tax efficiency. If you are struggling with planning for your IRA or have inherited an IRA, please call us at Meridian—we are happy to help you sort through your options and loop in the professionals needed to build your own custom plan.

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Ginger contemplating her estate plan

 

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