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How does the SECURE Act Affect Your Clients?

 

One of the main aspects of the SECURE Act, which was signed into law earlier this month, affects how beneficiaries receive money from inherited retirement accounts. The new rule stipulates beneficiaries of qualified retirement accounts, such as individual retirement accounts (IRAs) or 401(k) plans, must withdraw all money from the accounts within 10 years. Previously, beneficiaries were able to spread out withdrawals over their life expectancy. They are not held to required minimum distributions (RMDs) during that time, but the account balance must be at zero 10 years after they inherit it.

 

The benefit of spreading withdrawals over the beneficiary’s life expectancy, also known as the stretch IRA strategy, was fewer immediate tax consequences. The new law may result in higher tax bills, especially for beneficiaries in their peak earning years.

Who is Subject to the New 10-Year Rule?

Fortunately, if your clients have already been taking RMDs out of an IRA they inherited during or before 2019, those withdrawals aren’t affected by this SECURE Act rule change. The 10-year rule takes effect on January 1, 2020 and only applies to retirement accounts belonging to individuals who die in 2020 and beyond. Current beneficiaries of inherited IRAs and 401(k) plans can still withdraw the RMDs over their life expectancy.

What about Spousal Beneficiaries?

The 10-year rule only applies to non-spousal beneficiaries, so spouses who inherit IRAs or 401(k) plans can continue to stretch withdrawals over their life expectancy. Other exceptions include disabled beneficiaries and individuals who are not more than 10 years younger than the account holder, such as a slightly younger sibling. Minor children are also exempt from the rule but only until they reach age 18, at which point they have 10 years to withdraw all assets from an inherited account.

Best Ways to Withdraw from Inherited Retirement Accounts under 10-Year Rule

Although withdrawal strategy depends entirely on the individual’s situation, there are a few key factors to keep in mind. First, the withdrawals are taxed at the beneficiary’s income-tax rate, which may result in bigger tax consequences for those in their peak earning years. Secondly, beneficiaries who are within 10 years of their own retirement may want to consider delaying withdrawals from these inherited accounts until after they retire. That way, they can avoid taking withdrawals on top of their earned income.

Are there Alternative Options for Inherited Accounts?

Unfortunately, non-spouses cannot roll over an inherited IRA from one account to another. According to the IRS, their only option is to take distributions. Beneficiaries of 401(k) plans may roll the funds over to an inherited IRA. Although the new 10-year rule means drastic tax consequences for most beneficiaries, an alternative option for the benefactor is funding a life insurance policy. Rather than leaving an IRA as an inheritance, individuals can opt to pay premiums on a life insurance policy and name the desired heir as beneficiary. Since the benefactor pays taxes on the premiums, the beneficiary will receive tax-free funds with the insurance death benefit.

 

We encourage you to familiarize yourself with the SECURE Act and any rule changes associated with it. If you have clients who are affected, help them during the decision-making process and encourage them to speak with their financial advisor to formulate a plan that works best for their financial situation. Click here to read the SECURE Act legislation in full.

 

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