Gone With The Wind: Inherited IRAs and The Big Stretch
For years, beneficiaries could inherit a traditional IRA from a loved one and “stretch” it out by deferring unpaid income taxes for years or even decades with a life expectancy payout. The good times are largely over for many beneficiaries since the Secure Act and Secure Act 2.0 were passed in 2019 and 2022, respectively.
The most important thing to know is that the life expectancy payout is gone like the wind for beneficiaries other than a surviving spouse, minor child, disabled or chronically ill individual, or an individual who does not have this status and is not more than 10 years younger than the IRA owner (“Eligible Designated Beneficiaries” or “EBDs”). For non-EBD’s, a beneficiary is required to withdraw all assets from an inherited traditional IRA within 10 years of the IRA owner’s death, although he or she need not take 10 annual distributions if the IRA owner died before he or she was required to start taking his or her own minimum distributions. Instead, a beneficiary can take no distributions some years, or even fully distribute the IRA in year 10. But if the IRA owner died after he or she was required to start taking minimum distributions, then the non-EDB beneficiary will also be required to take annual distributions during the 10 years payout period, offering little wiggle room to avoid income spikes and the increased taxes that necessarily follow.
Suddenly, packing as much pre-tax money as possible into IRAs to pass down to your kids is no longer an automatic winning proposition if they are required to withdraw all assets from an inherited traditional IRA within 10 years of reaching majority (age 21), possibly making hundreds of thousands of dollars available to them at an early age over despite what your Will or Trust provides, and causing your hard-earned retirement savings to annually spike your children’s income over 10 years.
The Secure Act 2.0’s rules are far more complex than what can be written about in a blog post, however, some financial advisors are now recommending to clients that they convert traditional IRAs to Roth IRAs to avoid the imposition of the 10-year payout rule on non-EDBs of traditional IRAs. In general, Roth IRA distributions allow tax- and penalty-free withdrawal of contributions at any time. Earnings can be withdrawn tax-free if the account is at least 5 years old and the IRA owner is 59 ½ or older, disabled, deceased, a first-time homebuyer (up to $10,000), or a beneficiary. Best of all, there are no required minimum distributions during the owner’s lifetime. Non-EDB beneficiaries of a Roth IRA must take required minimum distributions, but the rules are far less harsh than for non-EDBs who have inherited a traditional IRA.
There is a very important timing consideration to Roth conversions: doing so in the 2 years prior to attaining Medicare eligibility (age 65) can result in a taxable income spike that triggers “income-related monthly adjustment amounts” (IRMAA), which are surcharges on Medicare Parts B and D that can triple or quadruple Medicare premiums by hundreds of dollars every month.
The Secure Act 2.0 has created a new, complex world for IRA holders and has dramatically changed the landscape for estate planning. This is an excellent time to have an estate plan check-up with an experienced attorney to ensure that current tax laws and regulations will yield the result you desire.
To learn more about The Secure Act 2.0, please contact Beresford Booth at info@beresfordlaw.com or by phone at (425) 776-4100.