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New rules change inheritance plans

Posted on February 17, 2020

In December 2019, the United States enacted the most significant retirement-planning reform in over a decade. Called the SECURE Act, short for Setting Every Community Up for Retirement Enhancement, it was tucked into Congress’ end-of-the-year budget package.

The change to the inheritance portion of this bill is now getting noticed because although it has a few retirement savings positives, it also contains potentially disastrous consequences for retirees who do not update their retirement plans with the new rules in mind.

The legislation was intended to reduce costs associated with setting up retirement plans for small employers, which it does by making it easier for them to band together in pooled plans. The legislation also allows part-time workers to contribute to 401(k) plans.

The SECURE Act also:

  • Raises the mandatory age to begin taking withdrawals from retirement accounts (RMDs) from 70.5 to 72
  • Eliminates the age 70.5 cutoff for retirement contributions to benefit those working later in life.

However — to fill the revenue gaps left by those changes, Congress killed the so-called stretch IRA. So, beginning Jan 1, 2020, if the owner of an IRA or 401(k) passes away and leaves the account to a beneficiary other than his/her spouse, minor children or heirs who are disabled or chronically ill, the beneficiary will have just 10 years to empty the entire account. (If your IRA is going to a spouse, the new 10-year rule does not apply.)

This is a significant change that eliminates a popular tax strategy whereby grandchildren drew from an inherited IRA over decades. Under the new regulation, required heir withdrawals could easily fall in the heir’s prime earning years and get taxed at top rates.

What to do if you are caught in these new regulations? One clear workaround: If you have a substantial IRA, slowly convert to a Roth IRA. By converting it piecemeal over a number of years, you can take advantage of present low tax rates. Once you’ve switched to the Roth, withdrawals by your heirs will be tax-free.

In some cases, you can also reduce the tax burden to heirs by naming separate beneficiaries, spreading the gains over many tax returns. Talk to a CPA at Teipen Selanders Poynter & Ayres for more solutions that work for your particular situation.