Understanding the SECURE Act: Inherited IRAs and the “Stretch” Concept

Mar 5, 2020

The SECURE Act, which was signed into law late last year, has several provisions that impact distribution rules for IRAs. Arguably the most noteworthy change is the partial elimination of the “stretch IRA”.

Starting in 2020, for IRAs passing to certain beneficiaries – non-eligible designated beneficiaries (not including spouses, minor children of the owner, chronically ill or disabled, those less than 10 years younger, and properly drafted “see-through” trusts) - the entire IRA must be distributed by the end of the 10th year following the owner’s death. Under prior rules, for IRAs inherited before 2020, beneficiaries can limit annual distributions to an amount based on a life expectancy factor. Older beneficiaries are required to withdraw more each year than younger beneficiaries.

The “stretch” concept hinges on a strategy whereby younger IRA beneficiaries receive the assets and extend the distributions and life of the IRA for a longer period of time. For instance, assume Tom passed away in late 2019 at age 85 and left equal shares of his $1,000,000 IRA to his two grandchildren, Nick who is 30 and Andrew who is 25 years old. The inherited IRA continues to fall under the old rules because Tom passed away in 2019. Nick and Andrew will each take a required minimum distribution in 2020 based on a life expectancy factor and then decrease that number by 1 in each subsequent year. Nick’s 2020 minimum distribution amount is $9,381 (1.9% of the IRA’s value) while Andrew’s is $8,591 (1.7% of the IRA’s value). If Tom selected a 55 years old beneficiary instead, the initial required minimum distribution would represent 3.4% of the account’s value. Although it’s still a relatively modest withdrawal rate, it’s twice as much as the 25-year-old Andrew must withdraw.

However, if Tom passes away in early 2020, the new SECURE Act rules will apply. Nick and Andrew, who are not chronically ill or disabled, must each withdraw their $500,000 inherited IRA balances (including growth) by no later than the end of the 10th full year following Tom’s death (i.e., December 31st, 2030). Aside from that, there are no annual withdrawal requirements. Although the timeframe for a full distribution is condensed, Nick and Andrew have significant flexibility in how to access the IRA over the 10-year period.

What are the planning considerations under this scenario?

First off, if you’re reading this and own an IRA, your IRA falls under the new SECURE Act rules. The old rules applied to anyone passing away before 2020. Also, if you have an inherited IRA, received from a loved one prior to 2020, nothing changes for you. The old rules still apply.

IRA and retirement plan owners should think through the impact of the new 10-year rule and discuss options with their financial advisor. Some people may be comfortable with the condensed distribution requirements - keep in mind, once the owner is gone and the IRA is in the hands of the beneficiary, nothing is stopping them from withdrawing the full IRA under the old rules, unless more sophisticated planning with trusts was implemented. On the other hand, larger, more condensed withdrawals can push beneficiaries into higher tax brackets and some IRA owners may want to be more strategic about how income taxes from distributions might impact their beneficiaries. A little bit of planning now can direct more of the IRA to beneficiaries and less tax dollars to the government.

Watch Our On-Demand Webinar

You can learn more about the SECURE Act and other ways it may impact your financial plan by watching our on-demand webinar.

Consult with an attorney or a tax or financial advisor regarding your specific legal, tax, estate planning, or financial situation. The information in this paper is not intended as legal or tax advice.

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