ALERT! There is a new law regarding inherited IRAs. Here are all the facts:
SECURE Act and the Death of the Stretch-IRA
On May 23, 2019, the House of Representatives passed the Setting Every Community Up for Retirement Enhancement Bill of 2019 (the “SECURE Act”). Congress just agreed to a bipartisan appropriations bill that will help avoid another government shutdown. Attached to the spending bill is the SECURE Act legislation which goes into effect on January 1, 2020, assuming President Trump signs the bill into law (which seems likely). This bill makes comprehensive changes to the laws governing IRAs and other retirement plans. While many of these changes benefit plan owners, one of them has a dramatic negative effect; namely, under the SECURE Act, the maximum period of time a non-spouse beneficiary of an inherited IRA has to withdraw the entire IRA, with limited exceptions, is 10 years. This is a massive change from current law, which allows a non-spouse individual beneficiary of an inherited IRA (or beneficiary of a properly drafted trust which receives an IRA) to “stretch” the inherited IRA out over his or her life expectancy when taking the required minimum distributions each year.
Example. To highlight the magnitude of the change, consider that under current law, a 21 year-old who inherits a $1 million IRA can “stretch” out distributions over his or her 62.1 year life expectancy, according to IRS tables, and has an initial required minimum distribution of only $16,103. Under the SECURE Act, the entire $1 million IRA must be withdrawn and taxes paid within 10 years.
Planning Opportunities and Pitfalls Under the SECURE Act
* Leaving an IRA to Charity. If you have charitable intent, reconfiguring your estate plan so that any charitable gifts come from your IRA rather than your Will or Trust will become even more tax efficient than under current law. Your individual beneficiaries will avoid having to pay income tax on your IRA within the compressed 10-year period and the charity will receive the entire IRA tax free. Your individual beneficiaries can receive your trust assets, which receive a step-up in cost basis at your death and are income tax free.
* Mimicking the Stretch-IRA by leaving it to a Charitable Remainder Trust (“CRT”). A CRT can be designed to draw out distributions for the lifetime of a child or other heir with the remainder going to charity.
* Naming trusts for young children or grandchildren as IRA beneficiaries. Under the SECURE Act, the 10-year stretch-out limitation does not apply to a beneficiary under 21. Thus, naming very young beneficiaries (or trusts for them) may increase the 10-year withdrawal period and increase the tax-deferred growth of the IRA.
* Use Discretionary Sprinkle Trusts to sprinkle IRA income among beneficiaries to minimize taxes.