The Setting Every Community Up for Retirement Enhancement (SECURE) Act went into effect on January 1, 2020. While the law was touted as a way to encourage retirement savings, some of the changes created by the SECURE Act actually limit the use of IRAs to build family wealth.
One of the major impacts of the new law is the partial elimination of the “Stretch IRA”, which has long been used to pass down family savings from generation to generation.
We want to make sure you understand just what the SECURE Act changed and how the new rules will impact your IRA, so we’ve broken it all down for you in this article.
An Individual Retirement Account, which we usually just called an IRA, is a type of personal retirement savings account that is not sponsored by an employer. If you invest in a traditional IRA, you can annually contribute up to $6,000 of your pre-tax income, or $7,000 annually after you turn 50.
Traditional IRAs are a type of "tax-deferred retirement account". This means that, even though you can initially invest in a traditional IRA with your pre-tax income, our pals at the IRS will eventually come knocking on your door. Once you reach a certain age, the IRS forces you to take required minimum distributions (RMDs) AND forces you to pay income taxes on those distributions.
Roth IRAs are a little different. With a Roth IRA, you can only invest post-tax income. Since you already paid taxes on the income, you won't be required to take minimum distributions. Once Uncle Sam gets his cut, he doesn’t care if you decide to keep your money in your Roth IRA.
When the owner of an IRA passes away, the remaining balance of the account is inherited by the designated account beneficiary. Just like the original account holder, owners of inherited IRAs must also take RMDs. However, the rules are a little different for beneficiaries.
A great example of how the rules are different for Inherited IRAs is that people who inherit Roth IRAs must receive RMDs from the accounts. Even though an original account owner does not have to take RMDs, if you inherit a Roth IRA and transfer the assets into an Inherited Roth IRA, you will have to take them.
The silver lining is that your RMDs will not be taxed as long as the funds have been in the account for five or more years. Since the original account owner paid income taxes on the money they invested in the Roth IRA, you get to make withdrawals from your inherited Roth IRA tax-free.
The SECURE Act made some drastic changes to how the designated account beneficiaries could choose to access funds from Inherited IRAs. First, we'll take a look at what the rules were before, and then we can talk about what the SECURE Act changed.
Before the SECURE Act went into effect, there were two sets of rules for account beneficiaries of inherited IRAs: one set of rules for spouses, and another set of rules for non-spouses.
Before 2020, if you inherited an IRA from your spouse, you had three choices:
A spouse who assumed ownership of the inherited account or rolled the balance over into their own account would just follow the standard RMD rules for themselves. The RMD age was 70½ before the SECURE Act came along, so spouses who chose either of these options would not have to take RMDs from the inherited balance before that age.
If a spouse decided to transfer the balance into an Inherited IRA, they would have to start taking RMDs regardless of their age. The RMD amount would be calculated each year using the IRS Single Life Expectancy Table.
Before the SECURE Act took effect, non spouse beneficiaries could transfer the balance into an inherited IRA and then select one of the following options:
What is a Stretch IRA? A Stretch IRA is not a specific kind of IRA, but an estate planning strategy that made use of a child beneficiary's ability to receive RMDs over their lifetime. Choosing this option would allow the funds in an IRA to maintain tax-deferred status for decades, with each IRA owner passing the account on to the next generation. By stretching out the lifespan of the IRA, families could avoid taxation on the funds in the account while accumulating wealth.
The amendments included in the SECURE Act raised the RMD age from 70½ to 72. They also drastically changed the options for accessing account funds available to certain types of Inherited IRA beneficiaries.
The SECURE Act identified several categories of people who were considered eligible designated beneficiaries:
In 2020, any eligible designated beneficiary who inherits an IRA still has the option to receive RMDs based on their life expectancy. Spouses can also still choose to assume ownership of the account or roll the balance over into their own account.
Any beneficiary who is not an eligible designated beneficiary must follow the 10-year rule instituted by the SECURE Act. The 10-year rule requires that beneficiaries withdraw (and pay taxes on) all of the funds in the account within 10 years. Once minor child beneficiaries turn 18, they are also subject to the 10-year rule.
In short, under the SECURE Act, any Inherited IRA beneficiary who is NOT an eligible designated beneficiary CANNOT choose to take RMDs over their lifetime.
By excluding adult children from the list of eligible designated beneficiaries, the SECURE Act drastically limited the usefulness of the Stretch IRA technique. While a surviving spouse can still elect to receive RMDs over their lifetime, children who are not disabled or chronically ill must follow the 10-year rule. This rule change eliminates the generational benefits of using a Stretch IRA and complicates remarriage estate planning. The changes made by the SECURE Act which will require many families to rework their estate planning strategies, and some may choose to divert their IRA investments to a different type retirement savings account.
Scott Royal Smith is an asset protection attorney and long-time real estate investor. He's on a mission to help fellow investors free their time, protect their assets, and create lasting wealth.
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