The CARES and SECURE Acts offered financial relief during COVID-19, and though some of the benefits of these acts are no longer in effect, some of the rules within them were enacted as permanent changes. Specifically, changes were made to how Inherited IRAs are treated and majority of those to be impacted will be those part of the Great Wealth Transfer. Over the next 25 years, Baby Boomers are expected to pass on upwards of $30-$40 trillion in assets to their beneficiaries. Many of these assets will be passed on from Retirement Accounts such as IRAs or 401(k)s.
When a beneficiary inherits a retirement account, they can treat this as either their own IRA or an Inherited IRA depending on their relationship to the original account owner. If you are a spouse, you have the option to treat the IRA as your own or take distributions over your life expectancy (depending on the age of the deceased owner).
The major change applies to the non-spouse beneficiaries. Before the SECURE Act passed in 2019, non-spouse beneficiaries were able to inherit a retirement account, transfer it into an inherited IRA, and then withdraw money from it over their lifetime. This was advantageous in that beneficiaries were able minimize the taxes on the distributions by stretching the required distributions out over their lifetime and letting the balance in the account grow tax deferred. This is often referred to as the Stretch IRA strategy.
Under the new law, non-spouse beneficiaries are now required to withdraw all the funds within 10 years of the original account holder’s death. You have the option to make withdrawals when you want either all at the beginning, in equal installments, or all at the end of the 10-year period. This offers a lot of flexibility but may require more planning because withdrawals can result in some unwanted tax bills. For example, one strategy may be to let the account grow for ten years and take out at the end to take advantage of tax-deferred growth, but that distribution may push your income tax bracket up a notch. Regardless of the Distribution strategy chosen, if the funds are not depleted over that 10-year period, there are significant penalties that would apply.
There are exceptions to the 10-year rule for eligible designated beneficiaries which include minor children, beneficiaries less than 10 years younger than original owner, and those disabled. It is also important to note that this 10-year rule only applies to decedents who pass after 12/31/2019. Any Inherited IRA that was established before that date may take advantage of the Stretch IRA strategy
With any change, comes the need to plan to make sure financial decisions are in line with your overall financial plan. As always, please reach out with any questions you might have.