As of Jan. 1, 2020, a new tax law is in effect that has killed what was known as the Stretch IRA and also trusts as beneficiaries to an IRA. Officially entitled the Setting Every Community Up for Retirement Enhancement Act (or the SECURE Act), the new law includes both welcome changes and controversial elements.
Previously, if you inherited an IRA from your parents or grandparents you were able to due what was known as a Stretch IRA. Under the old rules you could take Required Minimum Distributions (or RMD’s) over your lifetime, thus stretching them out potentially for decades while minimizing your tax bill. Under the new legislation beneficiaries of IRA’s are no longer required to take RMD’s but you must empty the inherited IRA within 10 years.
If you inherited an IRA before Jan. 1, 2020 you are grandfathered in and can still take advantage of the old rules. For the rest of us, Congress has decided that IRA’s are for retirement and not to pass on to heirs. This change is going to lead to potential tax problems in the future for the beneficiaries of IRA’s.
There are however exceptions for spouses, minor children (until they reach the age of majority), disabled individuals, the chronically ill, and those within 10 years of age of the decedent.
In addition to the initial tax bite and the implications for estate planning, you may lose out on the tax deferred benefits that accrue from sheltering assets in an IRA account over an extended period of time.
Trusts as Beneficiaries—Changes Are Coming
Clients with large IRA’s sometimes name a trust as the beneficiary for two reasons. First, they want control beyond the grave and secondly to minimize taxes. There are two types of trusts used in this capacity: conduit trusts and discretionary (accumulation) trusts.
With a conduit trust, distributions from the inherited IRA go into the trust and then pass on to the beneficiaries of the trust. This way, all the funds distributed to the beneficiaries get taxed at their own personal tax rate. Because there are no more RMD requirements, but all of the funds must be distributed in 10 years, this could potentially create tax problems for the beneficiaries.
With an accumulation trust, the distributions from the inherited IRA are paid to the trust and the trustee has greater discretion as to whether the funds will be held within the trust or paid to the beneficiary. While this provides greater control, it may come at the cost of much higher taxes. As you may already be aware, the tax rate applied to funds in a trust is much steeper than individual tax rates, i.e., income over $12,750 in the trust is taxed at 37%.
Of course, what I have provided here is simply a broad overview. There may be other options to consider.
For most folks, the death of the stretch IRA is creating some challenges on the estate-planning front. We are happy to discuss alternatives and reduce some of the confusion surrounding the new law.
Some Positive Long Overdue Changes
- If you turned 70½ on Jan. 1, 2020 or later, the initial required minimum distribution (RMD) for a traditional IRA is being raised from 70½ to 72.
- You may continue to contribute to a traditional IRA past the age of 70½, as long as you are working and have earned income.
- Qualified Charitable Distributions: You may continue to directly transfer up to $100,000 per year to a qualified charity from your IRA at 70½. You may also decide to wait until you are 72 to donate via a QCD, which will satisfy the RMD requirement.
People are living and working longer. In our view, these changes are welcome.
I strongly suggest if you find yourself in any of these situations that you work with your Advisor and CPA to come up with a game plan. There are a few strategies that can help reduce or at least manage your tax burden.
If you have any questions or concerns, I’d be happy to have a conversation with you. As always, I’m honored that you have given me the opportunity to serve as your financial advisor.
David R Henderson
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