Secure Act of 2019 Means More Taxes for Your Heirs Without Thoughtful Planning
The SECURE Act, which takes effect on January 1, 2020, includes many changes for individual retirement accounts (“IRAs”) including raising the age at which required minimum distributions must be taken from age 70 ½ to age 72 and eliminating the age limit for contributions to IRAs so that as long as you are working, you can make contributions. The increased age for required minimum distributions also applies to qualified plans (e.g., 401(k)s).
The SECURE Act also eliminates the “stretch” distributions from IRAs and qualified plans in all but a few circumstances. Currently, when a retirement account owner dies and a beneficiary (other than the owner’s spouse who has additional options available) inherits the account, that beneficiary has the ability to stretch withdrawals from the account over his or her lifetime. For younger beneficiaries, this meant slowly withdrawing the money over multiple decades, which allowed the assets to compound on a tax-deferred basis. Starting in 2020, most beneficiaries will generally be required to withdraw assets from an inherited account within ten years of the owner’s death. It is estimated that this accelerated withdrawal will raise $15.7 billion in taxes over the next ten years.
As with most tax laws, the new law includes exceptions to the general rule. Those who are still eligible to withdraw assets over their life expectancy include:
- Those who inherit IRAs before January 1, 2020,
- Surviving spouses,
- Disabled or chronically ill individuals,
- Individuals who are not more than ten years younger than owner, and
- Children of the owner who have not reached the age of majority until they reach the age of majority at which time the ten-year withdrawal rule applies.
While we wait for regulations to be issued to address some of the open questions about the application of the new law, there are several strategies that you may consider in an effort to reduce the tax cost of passing retirement accounts to your heirs.
- Generally, making your spouse the beneficiary of your retirement account will remain the most favorable option. With respect to a Roth IRA, the spouse could roll it over and not take distributions during the spouse’s lifetime and then leave the Roth IRA to beneficiaries who will have a ten year stretch. If the IRA is a traditional IRA, then the spouse could convert some or all of the IRA to a Roth IRA during lifetime or take distributions beyond the required minimum distributions if the spouse is in a lower tax bracket than the anticipated heirs.
- Those who must withdraw within ten years could choose to wait until the end of the ten-year period to allow for maximum growth. While this strategy may work well for Roth IRAs, in the case of a traditional IRA such a strategy could push the person into a higher tax bracket.
- Leave your retirement account to multiple beneficiaries (ideally those in lower tax brackets) so that more people are spreading the income over the ten year period to minimize their being bumped to a higher tax bracket.
- If you are charitably inclined, you could leave your retirement account to a charity or a charitable remainder trust (“CRT”) to reduce the amount of income and estate taxes that might otherwise be imposed. The use of a CRT can have the net effect of stretching distributions and income realization over a period of time in excess of the ten year required payout. However, the amount remaining in the CRT at the end of the term will pass to charity and not your heirs.
Whether any of the above strategies or additional strategies not listed will work for you depends entirely on your particular situation so you should contact your tax advisor for further analysis. As with any change to the tax laws, you should review your current estate plan to make sure it still makes sense for you especially if you have trusts that will hold retirement assets. Lastly, the new law changes the rules for charitable contributions made from retirement accounts so you should consult with your tax advisor before making charitable gifts from your retirement account in 2020.