By Landon Hodges, Esq.
As part of the spending bill passed by Congress and signed by the President in December 2019, the Setting Every Community Up for Retirement Enhancement Act of 2019 (the “SECURE Act”) is now law and is effective beginning January 1, 2020. This law makes major changes in the way required minimum distributions in IRAs and Roth IRAs are treated as you age and when they are inherited by your beneficiaries. Prior to the SECURE Act, all owners of an IRA were required to begin taking required minimum distributions (RMDs) from their IRAs once they attain age 70½. Once the account holder passed away, the RMDs a non-spouse beneficiary must take were determined based on the life expectance of the beneficiary. For example, if you designated a 40-year old child as a beneficiary of your IRA, he or she may stretch those RMDs across his or her life expectancy, which allowed beneficiaries to stagger the income taxes across a larger period of time while taking advantage of tax-free growth on the funds remaining in the IRA.
Following the passage of the SECURE Act, IRA owners are allowed to postpone RMDs until age 72, allowing more time for tax-free growth for the account owner. Also, this law removes the prohibition on IRA contributions after age 70½, allowing individuals to contribute to their IRAs for a longer period of time. This is good for those who are trying to reduce their taxable income for as long as possible, but it could also result in larger IRAs at the time of death, which will then be passed to your beneficiaries and subject to their income tax calculations.
Effects of the SECURE Act on inherited IRAs
Under the SECURE Act, all IRAs and Roth IRAs, with some exceptions, must be paid to the designated beneficiaries within ten years following the owner’s death. Of course, this means that the entire balance of an inherited traditional IRA will be income taxable to the beneficiary within ten years following the owner’s death. With this account also being subject to Pennsylvania inheritance tax, this could lead to significant taxes for beneficiaries of IRAs. Exceptions to this ten-year rule include beneficiaries who are the owner’s spouse, the owner’s minor child, disabled, chronically ill, or are less than 10 years younger than the account owner. If one of these exceptions are met, or if the IRA is left to a trust of which one of these persons is the direct beneficiary, the old life expectancy rule will apply.
What About your Existing Trusts?
If you have a trust as a beneficiary of an IRA, it is important to think about how this law will affect the tax ramifications for your beneficiaries following your death. If you have minor children or children with disabilities, you can create a direct beneficiary trust or supplemental needs trust for the benefit of that person to avoid the new ten-year rule. If you have not done so recently, this is a good time to have your trust reviewed to ensure that it is compliant with this new law and that the tax calculations are still advantageous to your beneficiaries.
What Should I Do?
Give us a call to schedule an appointment to review your estate plan and to discuss any questions you have about your retirement plans. If you have any charitable causes which interest you or any non-profit organizations you wish to support, these are great beneficiaries for IRAs because they are not subject to income tax or Pennsylvania Inheritance Tax. Leaving your IRA directly to a charity, or to a charitable trust, is a great way to maximize the effect of your money and to ensure that the money left to your family is not going to leave them with income tax ramifications down the road. If you have traditional or Roth IRAs, this is a great time to review your existing beneficiary designations and estate plan with a qualified professional.