Whether you’re already retired, planning to retire soon or just beginning your savings journey, key provisions of the recently enacted SECURE Act demand your attention, especially the legislation’s impact on individual retirement accounts, or IRAs.
One of the biggest changes is that the SECURE Act eliminates the so-called “stretch IRA,” said Kimberly Bridges, director of financial planning at BOK Financial. “Loss of the stretch IRA will impact estate planning for many high net worth individuals.”
Prior to the new rules, estate plans were often set up to maximize tax deferral by leaving IRA assets to children, thus stretching distributions over their lifetime. Beginning this year, the new rules require beneficiaries of an inherited IRA to withdraw the money within 10 years, with certain exceptions for spouses, minors and disabled beneficiaries.
Under the rule, children or younger family members who inherit an IRA in their highest earning years would face stiffer tax consequences, Bridges said. “Depending on when the 10-year distribution period falls relative to their career path, beneficiaries could be forced to distribute inherited IRA assets during their highest income years, subjecting them to even higher tax rates.”
“The 10-year rule doesn’t apply to spouses and named beneficiaries whose age is within 10 years of the deceased, such as a sibling or life partner,” Bridges said. “But for others, IRAs may not be the best avenue to pass wealth to future generations. They can be a very tax inefficient gift for most members of your family.”
Speak with your advisor about the best scenario for your family’s situation, she said. For your own estate planning, consider all the options, including these alternatives:
- A Roth IRA (which is funded with after-tax contributions) may be better for children who will inherit it. Roth IRAs are still subject to the 10-year withdrawal rule but are not taxed, as long as the account owner held the account for more than five years.
- A parent could consider taking qualified distributions of some of their IRA funds during a period in which their tax burden is reduced, and using the proceeds to buy life insurance. Life insurance is typically a more tax efficient asset to leave to heirs. This strategy should only be used if the IRA funds will not be needed by the parent for their own lifestyle goals.
“One benefit of life insurance is that it can be purchased and held within a trust, allowing the estate owner to essentially ‘control the assets from the grave,’” Bridges said. “The parent would define provisions prior to death that would determine the amount and timing of asset distribution to their children, which makes it a tax efficient approach with more control.”
- IRA owners could consider a qualified charitable distribution to support causes that are important to them while also lowering their income tax bill. At age 70 ½, IRA owners can begin qualified charitable distributions of up to $100,000 per year. The distributed amount would not be added to their adjusted gross income.
Bridges cautions that individuals can now contribute to an IRA past 70 ½ if they still have earned income. If you plan to keep funding your IRA, you may want to avoid making a qualified charitable contribution in the same year as it may offset the tax benefits of the contribution.
As always, consult your financial planner and tax advisor to understand the changes and to avoid any unintended consequences.