
The Setting Every Community Up for Retirement Enhancement (SECURE) Act, passed by Congress and signed into law in late 2019, represents one of the most significant overhauls of retirement-related legislation in decades. While the Act is designed to improve retirement savings opportunities for Americans, it has also introduced key changes that affect how retirement accounts are inherited by beneficiaries. Understanding these changes is crucial for anyone engaged in estate planning, as they can have significant tax and distribution implications for your heirs.
In this blog post, we’ll break down the key provisions of the SECURE Act and explain how they impact the beneficiaries of your retirement accounts.
What Is the SECURE Act?
The SECURE Act was enacted to help Americans save more effectively for retirement, expand access to retirement plans, and promote longer working lives. While many provisions of the Act focus on encouraging retirement savings, its changes to how retirement accounts—such as 401(k)s and IRAs—are inherited by beneficiaries have drawn significant attention. These changes can have far-reaching implications for estate planning and the financial futures of your heirs.
Key Provisions of the SECURE Act
The SECURE Act introduced several major changes to retirement account rules. Some of the most notable include:
Elimination of the Stretch IRA: The most significant change for beneficiaries.
Changes to Required Minimum Distributions (RMDs): Adjustments to the age at which retirees must start taking distributions.
New Beneficiary Distribution Rules: Introduction of the "10-year rule" for most non-spousal beneficiaries.
Additional Exceptions for Certain Beneficiaries: Special rules for certain classes of heirs.
Let’s dive into how these changes specifically affect the beneficiaries of retirement accounts.
1. Elimination of the Stretch IRA
One of the major impacts of the SECURE Act is the elimination of the Stretch IRA for most non-spousal beneficiaries. Under prior law, beneficiaries of an inherited IRA or 401(k) could "stretch" required minimum distributions (RMDs) over their lifetime. This allowed for continued tax-deferred growth of the inherited account, potentially minimizing the annual tax burden for beneficiaries by spreading distributions—and the corresponding taxes—over many years.
How the Elimination of the Stretch IRA Affects Beneficiaries:
Pre-SECURE Act: A non-spousal beneficiary could take smaller RMDs based on their life expectancy, allowing the balance to continue growing tax-deferred.
Post-SECURE Act: Most non-spousal beneficiaries must now withdraw the entire balance of the inherited retirement account within 10 years of the account owner’s death.
This change significantly shortens the time horizon for taking distributions and paying the associated taxes, potentially leading to larger tax burdens for beneficiaries during their peak earning years.
2. The New 10-Year Rule for Beneficiaries
Instead of the lifetime distribution option that existed before, the SECURE Act mandates that most non-spousal beneficiaries must withdraw the entire inherited IRA or 401(k) within 10 years. This is known as the 10-year rule.
How the 10-Year Rule Works:
There are no annual RMDs required under the new rule. Beneficiaries can take distributions as needed, provided the entire balance is withdrawn by the end of the 10th year following the account holder’s death.
This gives some flexibility in timing withdrawals but requires careful planning to manage the potential tax impact.
Impact on Beneficiaries:
Beneficiaries may face higher tax liabilities, especially if they are forced to take large distributions during their highest-earning years.
Without proper planning, the new rules could result in significant portions of the inherited account being taxed at higher income tax rates.
The shortened time frame for tax-deferred growth may reduce the overall value that beneficiaries can extract from inherited retirement accounts.
3. Exceptions to the 10-Year Rule
While most non-spousal beneficiaries must follow the 10-year rule, the SECURE Act provides exceptions for certain categories of beneficiaries, allowing them to continue taking distributions based on their life expectancy.
The exceptions to the 10-year rule include:
Spouses: A surviving spouse can still roll the inherited retirement account into their own IRA and take distributions based on their own life expectancy.
Minor Children: Minor children of the account owner are allowed to take distributions over their life expectancy until they reach the age of majority. Once they reach the age of majority, the 10-year rule kicks in.
Disabled or Chronically Ill Individuals: Individuals who are disabled or chronically ill can take distributions over their lifetime, bypassing the 10-year rule.
Beneficiaries Less Than 10 Years Younger: Beneficiaries who are less than 10 years younger than the deceased account holder can also use the old lifetime distribution rules.
4. Required Minimum Distribution Age Raised to 73
Another key provision of the SECURE Act is the change in the Required Minimum Distribution (RMD) age. Previously, retirees were required to start taking RMDs from their retirement accounts at age 70½. The SECURE Act raised this age to 72 (and later updates have moved it to 73 for those born after 1950).
Why This Matters:
This change gives retirees more time for tax-deferred growth in their retirement accounts before they must begin drawing from them.
Beneficiaries of retirement accounts could also see larger inherited balances due to the extended time for the original account holder’s assets to grow tax-deferred.
5. Planning for the SECURE Act’s Impact on Beneficiaries
Given the changes introduced by the SECURE Act, it’s important to review and possibly revise your estate plan to ensure your beneficiaries are in the best position to manage any tax burdens and maximize the value of their inheritance.
Considerations for Estate Planning:
Review Beneficiary Designations: Ensure your beneficiary designations on retirement accounts are up to date. You may want to consider different strategies based on the new 10-year rule.
Roth Conversions: Converting traditional IRAs or 401(k)s into Roth accounts can provide tax-free distributions for beneficiaries, which may mitigate the tax impact of the 10-year rule. While the conversion itself will trigger a tax event, it may provide long-term tax savings for your heirs.
Trusts: If your retirement accounts were left to a trust, you should revisit the structure with an estate planning attorney. The new distribution rules may limit the effectiveness of certain types of trusts, particularly conduit trusts, which may no longer allow lifetime payouts.
Charitable Remainder Trusts (CRT): For those looking to leave retirement assets to beneficiaries while reducing the tax burden, a CRT can be an effective tool. It allows for lifetime income for beneficiaries and a charitable donation after their death.
Conclusion: The SECURE Act’s Lasting Impact on Beneficiaries
The SECURE Act has fundamentally changed how retirement accounts are inherited, particularly with the elimination of the Stretch IRA and the introduction of the 10-year rule. These changes can have significant tax implications for your beneficiaries and may reduce the overall value of inherited retirement accounts.
If you have significant retirement assets or have named non-spousal beneficiaries for your accounts, it’s essential to review your estate plan in light of these new rules. By working with an experienced estate planning attorney and financial advisor, you can ensure your plan is tailored to minimize taxes and preserve the maximum value for your heirs.
As with any major legislative change, adapting your estate planning strategy to the new rules can help protect your legacy and provide peace of mind for your loved ones.
Contact the top-rated California probate attorneys Moravec, Varga & Mooney – today to schedule a telephonic consultation. Have questions, call (626) 460-1763 or email LV@MoravecsLaw.com.
Southern California Probate Lawyer Serving all counties in California, including Los Angeles, Riverside, San Bernardino, Sacramento, Santa Cruz & Beyond.
Comments