Many seniors dream of helping to shore up a loved one’s financial future by leaving a sizable inheritance after they die. But if retirees aren’t careful, they could also end up leaving behind a hefty tax bill.
In December 2019, Congress passed the Setting Every Community Up for Retirement Enhancement Act, the biggest retirement-related legislation enacted in more than a decade, and some experts believe more reforms lie ahead (see SECURE Act 2.0: 10 Ways the Proposed Law Could Change Retirement Savings). Some of the changes from the 2019 law were positive. For instance, the age for taking required minimum distributions was raised to 72.
By far and away, however, the SECURE Act’s most damaging legacy was the end of the stretch IRA, which upended carefully crafted estate plans to transfer retirement savings to the next generation. “We hear from a lot of clients that they don’t necessarily need all of their RMDs to live off of,” says Roger Young, a senior retirement insights manager at investment management firm T. Rowe Price in Baltimore. “Instead, they are looking to preserve those balances for their heirs.”
Before the SECURE Act, heirs who inherited a traditional IRA could take required minimum distributions based on their own life expectancy, stretching out the time to withdraw the money and leaving more of it in the account to grow tax-free. The stretch IRA, as it came to be known, also meant a potentially lower tax bill because the withdrawals could be spread out over many years, keeping the beneficiary’s taxable income in check. The rules were essentially the same for an inherited Roth IRA. Even though Roth IRAs do not have RMDs for the original owner, heirs were required to withdraw the funds based on their own life expectancy. The distributions, though, were tax-free as these accounts are funded with post-tax dollars.
Now, spouses who inherit a traditional or a Roth IRA can still use the stretch IRA, but the SECURE Act eliminated this option for most other heirs, who instead must empty the account within 10 years. Exceptions include heirs who are disabled or chronically ill or not more than 10 years younger than the original owner. An underage child of the original owner can also stretch out the IRA generally until the age of majority, when the 10-year rule kicks in. The new requirements apply to IRAs inherited after Dec. 31, 2019.
All of this has left Americans struggling to find the most tax-efficient ways to leave inheritances and replace the stretch IRA. “The impact the SECURE Act had on living people with their own retirement plans was incremental,” says Mark Worthington, senior counsel at the Special Needs Law Group of Massachusetts in Farmington. “What happens when you die is where the changes were mind blowing.”</…….