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Loss of Stretch IRAs Could Cost Your Beneficiaries

In December 2019, Congress passed the SECURE Act which brings significant changes to planning for the distribution of retirement assets after death.  Lifetime minimum distribution rules are pretty much left alone, with the only change being a delay in the starting point for required minimum distributions to age 72, from age 70½.

The most notable change resulting from the SECURE Act is the elimination of the so-called “stretch” provision for most (but not all) non-spouse beneficiaries of inherited IRAs and other retirement accounts.  Under the previous law, non-spouse designated beneficiaries could take distributions over their life expectancy, or the life expectancy of the oldest beneficiary of certain types of “see-through” trusts. 

Under the SECURE Act, the rules for designated beneficiaries change radically effective for deaths after 2019. Designated beneficiaries are now subdivided into two classes: “designated beneficiaries” and “eligible designated beneficiaries.” 

For designated beneficiaries, there is a new 10-year rule. Such beneficiaries will not be required to take annual distributions. Instead, the entire balance of the retirement/IRA account must be distributed within 10 years after the death of original owner. 

The new law imposes a drastically accelerated distribution schedule compared with the life expectancy payout regime that has been with us since the 1980s. The “best middle-class tax shelter” has been turned into a “worst middle-class tax trap.” * However, designated beneficiaries will have some flexibility when it comes to timing distributions from the inherited account for maximum tax efficiency…as long as the entire account balance has been taken by the end of the 10th year after death.**

The new 10-year rule does not apply to everybody. Five groups, called “eligible designated beneficiaries,” will still be able to use a modified version of the life expectancy payout. These are: the surviving spouse of the participant; a minor child of the participant (however, the minor’s life expectancy payout flips to the 10-year rule when the minor reaches majority); a disabled individual; a chronically ill individual; and an individual who is not more than 10 years younger than the participant. But there are a few considerations related to eligible designated beneficiaries to note.  First, the minor child must be the child of the deceased owner; thus, minor beneficiaries of grandparent’s accounts would not qualify for this exception.  Second, the “see-through” trusts may need to be revised to allow for periodic distributions to beneficiaries to avoid having the entire balance being held and either taxed at Trust tax rates, or distributed all in year 10 at much higher marginal tax rates.  Also of note, at the death of an eligible beneficiary, the 10-year rule will kick in.

Much needs to be sorted out about exactly how SECURE will apply, so it is important to review your beneficiaries with your financial planner to be sure they are appropriate under the new law. 

*Natalie Choate, Morningstar 1/8/2020

**Nerd’s Eye View, Michael Kitces 12/23/2019

The opinions expressed in this article are those of author and should not be construed as specific investment advice. All information is believed to be from reliable sources, however, no representation is made to its completeness or accuracy. All economic and performance information is historical and not indicative of future results. Any tax advice contained herein is of a general nature. Further, you should seek specific tax advice from your tax professional before pursuing any idea contemplated herein. 

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