Before the SECURE Act being signed into law on December 20, 2019, a common strategy for ensuring a beneficiary gained the largest possible benefit from an inherited IRA was to “stretch” distributions throughout their lifetime and thereby avoid unnecessary income tax. Under the new legislation, this option has been all but wiped out except for in limited cases; accordingly, those inheriting an IRA or 401K plan require alternative strategies for making the most of their situation.
Spousal vs. Non-Spousal Beneficiaries
Spousal beneficiaries continue to be able to employ stretch planning by rolling an inherited IRA or 401K plan into their own IRA and thereby calculate required minimum distributions (RMDs) based on their age instead of that of the original account holder. Non-spousal beneficiaries who are neither minor children nor chronically ill or disabled can no longer do so and now must withdraw funds from an inherited account within ten years of the original account holder’s death (and pay income tax when doing so). Luckily, alternatives to stretch planning exist and when properly employed can do nearly as good a job of preserving your wealth.
Options Available to Non-Spousal Beneficiaries
1. A Roth IRA
If time is on your side and have not yet inherited an IRA but, rather, are investigating ways to make the most of doing so when the time comes, a Roth IRA is worth considering. Roth IRAs are funded with after-tax money and remain tax-free as they grow. What’s more, if you withdraw funds after age 59½ this, too, is shielded from tax.
A beneficiary of a Roth IRA will still need to empty the account within ten years of the account holder’s passing but they need not pay income tax on the money they receive when doing so. This means that if no urgent financial need exists, funds could be left to grow tax-free for the entire ten years before being withdrawn in a single lump sum.
A traditional IRA can be converted into a Roth IRA, though detailing how to do so is beyond this article. That said, with current tax rates historically low, now is a good time to consider this option.
2. An Inherited IRA Account
While non-spouses cannot roll an inherited IRA into their own IRA, they can set up an inherited IRA account which allows funds to continue growing tax-free until withdrawn. Because this account remains in the name of the original account holder, RMDs are unchanged. This means that if the benefactor passed away before age 70½, the beneficiary must begin receiving distributions either by the end of the year the account holder would have turned 70½ or by the end of the year of their death—whichever is later. Unlike the Roth IRA, distributions received from an inherited IRA account are subject to income tax, and yet depending on timing and your financial situation, this may be your best option.
3. Primary Beneficiary Changes
Changing beneficiary arrangements may be an effective way to diminish the impact of the SECURE Act if you are working with time on your side. After all, the problem with the ten-year rule is that a beneficiary will face increased income tax when accessing their inheritance. If distributed among multiple beneficiaries, your wealth may take less of a hit.
Imagine, for instance, that you name your spouse and three children as primary beneficiaries of your IRA. While your children will have to spend their portion within ten years, your spouse needs not and so when they die and pass their IRA (which now also includes yours) onto your children, an additional ten years are added to the clock.
While none of the above options manage to perfectly mimic the advantages of the stretch strategy, they nonetheless present powerful tools that assist in protecting your wealth. For more on which strategy is best suited to your situation, do not hesitate to give our office a call at (216) 341-3413 or reach us through the contact form on our website.
Contact the Estate Planning Attorneys at Deliberato Law Center