If you plan to leave a hefty part of your IRA to your adult children, you may want to schedule an appointment with your estate-planning attorney and your financial planner. Don’t be surprised if they’re booked up for a few weeks.
That’s because the Setting Every Community Up for Retirement Enhancement (SECURE) Act, signed into law at the end of 2019, contains a worrisome provision for diligent savers and their heirs. Starting in 2020, non-spouse heirs who inherit IRAs or 401(k)s lose the ability to “stretch” their required minimum distributions (RMDs) from an inherited account over their own lifetime. Rather, they must drain the account within 10 years after the year of the owner’s death. That means losing what could be decades of tax-free growth, forcing larger withdrawals and potentially jacking up the beneficiary’s tax bills in what might be his or her prime earning years.
“Congress pulled the rug out from under people who saved for years under tax rules they thought were certain,” says Ed Slott, founder of IRAHelp.com. If you inherited an account from someone who died in 2019 (or earlier), you can still stretch payments over your lifetime. Plus, the rules for married couples don’t change, so a surviving spouse can roll an inherited IRA into his or her own IRA and postpone required distributions until age 72 (boosting the age when you start RMDs is another provision of the SECURE Act). Minor children—but not grandchildren—can stretch an inherited IRA until they reach the age of majority, or until age 26 if they’re still in school. Disabled or chronically ill beneficiaries, or beneficiaries who are not more than 10 years younger than the deceased, are also exempt from the new, stricter rules.
Make a new plan. If you planned to leave an IRA to adult children, contact your financial adviser and estate planner to discuss your next steps—but first ask if they are up to date on the new rules. In particular, you’ll need to rethink your estate plan if you left your IRA to a trust. If a retirement plan is left to a trust and the language states that the beneficiary gets only the RMD each year, it could result in one giant distribution in the 10th year after the year of death.
You might also want to reconsider your beneficiaries. “In the past, many people left IRAs to their children or grandchildren if their spouse didn’t need the money, because their kids had a longer life expectancy,” says Jeffrey Levine, of BluePrint Wealth Alliance. You may want to split your IRA among your spouse and children. If you die before your spouse, your children end up with a smaller pot to withdraw over the compressed time line. When your spouse dies and leaves an IRA to your children, they get a new 10-year time line for the rest of the money.
Even better, consider converting your traditional IRA in stages to a Roth. Your heirs will still need to empty the account in 10 years, but they won’t be taxed on the money, so they could wait until the 10th year and benefit from nine years of tax-free growth.
More time for IRAs to grow. For those approaching retirement, the news is better. Anyone who didn’t turn 70½ by the end of 2019 (in other words, those born on or after July 1, 1949) can now delay taking RMDs from 401(k)s and traditional IRAs until the year they turn 72. Those turning 70 early in 2020 get almost two extra years of tax-deferred growth. The higher RMD age also gives you more time to convert more of your IRA money to a Roth before RMDs begin.
More ways the SECURE Act could affect you
- Starting in 2021, part-time employees will be able to contribute to a 401(k) plan. In the past, employees who worked fewer than 1,000 hours during the year typically weren’t allowed to participate in their employer’s 401(k) plan.
- Parents can take penalty-free withdrawals of up to $5,000 from a 401(k) or IRA after the birth or adoption of a child.
- 401(k) plan administrators will be required to provide an annual estimate of how much money plan participants could get each month if they used the account balance to buy an annuity.
- Workers can now contribute to a traditional IRA after age 70½ (but they may be better off contributing to a Roth instead).
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