You Inherited an IRA under the SECURE Act—Now What? - Rodgers & Associates

You Inherited an IRA under the SECURE Act—Now What?

In 2019, the Setting Every Community Up for Retirement Enhancement (SECURE) Act made signif­icant changes to the rules for retirement accounts.

The most notable change removed the “stretch” provision for certain benefi­ciaries of inherited retirement accounts, replacing it with a 10-year rule. Whereas the stretch provision allowed benefi­ciaries to make distri­b­u­tions from an inherited account over multiple decades, the new provision requires that they entirely deplete the account within 10 years after the original owner’s death.

While changing this clause makes it more difficult to minimize income taxes, fortu­nately, there are still strategies to help.

Let It Ride

One strategy is to leave the inherited funds in the retirement account for as long as possible. Since the SECURE Act allows for distri­b­u­tions at any time and amount (as long as the account is depleted by the end of the 10th year), the benefi­ciary could hold off on withdrawals during the first nine years. Then in the 10th and final year, they could distribute all the funds in the account.

This strategy preserves the tax-deferred status of the inherited account for as long as possible, though it may not be advisable if the final distri­b­ution pushes the benefi­ciary into a higher tax bracket.

Here are three scenarios where delaying distri­b­u­tions makes sense:

  • When the inherited account is a Roth IRA. The longer a Roth benefi­ciary leaves the money in the inherited Roth account, the longer the funds can continue to grow tax-free.
  • When the benefi­ciary is already in the highest tax bracket (currently 37%). In this case, the final distri­b­ution can’t push the benefi­ciary into a higher bracket, and few taxpayers benefit more from the power of tax-deferred growth than those in the highest bracket.
  • When the balance in the account is small. Someone inher­iting a lower balance may be unlikely to reach a higher tax bracket, even after 10 years of growth.

Spread It Out

Another strategy is to spread out the account income over as many years as possible.

Since the 10-year rule begins in the calendar year following the year of the account owner’s death, some benefi­ciaries might have the option to extend distri­b­u­tions over as many as 11 tax years.

If death occurs early in the calendar year, a benefi­ciary could have enough time to establish an inherited IRA and take a distri­b­ution from the account before the end of the year. This first distri­b­ution would occur in “year 0” of the 10 years, allowing the benefi­ciary to spread the income from the inherited account over 11 tax years. This approach doesn’t come close to the multi-decade timeframe of the stretch provision, but it can still help minimize taxes.

Time The Distributions

While spreading out distri­b­u­tions can be an effective strategy for benefi­ciaries with stable income, yet another strategy benefits those antic­i­pating income swings. These benefi­ciaries can make distri­b­u­tions during the years other income is lower.

Here are a few scenarios where lumping taxable distri­b­u­tions from inherited accounts might make sense:

  • The benefi­ciary, or their spouse, will be retiring
  • A child will be applying for student aid
  • A signif­icant chari­table gift is planned
  • The benefi­ciary intends to marry and can benefit from the lower tax rate of their married-filing-jointly bracket
  • The benefi­ciary will reach age 70 ½, becoming eligible to make qualified chari­table distri­b­u­tions from the account

While the 10-year rule is one of the biggest impacts of the SECURE Act, these strategies can help minimize income taxes. Designing a distri­b­ution plan that captures income in the most tax-efficient years is the best defense for benefi­ciaries subject to the new rule.

Rick’s Insights

  • The SECURE Act of 2019 removed the stretch provision for benefi­ciaries of inherited retirement accounts and replaced it with a 10-year rule.
  • Under the 10-year rule, distri­b­u­tions may be taken at any time and amount, but all money must be distributed by the end of the 10th year.
  • The first distri­b­ution can occur in “year 0,” allowing some benefi­ciaries to spread income out over 11 tax years.