How To Make The Most of Your Inherited IRA

The SECURE Act has introduced many changes to previous retirement legislation. Many of its provisions are designed to make retirement savings more accessible by granting wider access to 401(k) plans and increasing the age for RMDs, allowing pre-retirees to gain a couple of extra years to build their nest eggs.

But not all of the changes presented in this legislation are as popular. One of the main sectors of your financial plan that could be impacted by the SECURE Act is your estate plan. Our Wealth & Trust Officers are acutely aware of these changes and want to help you adjust and revise your plan accordingly.

The change we are going to talk about today involves inherited IRAs. What provisions regarding inherited IRAs have changed with the passing of the SECURE Act and how will they impact you? Let’s find out.

The SECURE Act + Inherited IRAs

Passed in December 2019, the SECURE Act affects almost everyone who owns an IRA. Individual Retirement Accounts (IRAs) are popular savings vehicles for retirement, but they are also common accounts used to pass down wealth and assets to beneficiaries. However, the latter has all but changed.

One of the most impactful changes of the SECURE Act is that we can no longer “stretch” out payments to avoid paying a large tax bill. Let’s dive a little deeper into the stretch provision and how it worked. In previous years, non-spouse beneficiaries of an inherited IRA could make use of the stretch provision and extend withdrawals from inherited accounts over the course of their lifetime.

This is particularly beneficial for individuals who have a large inheritance because all distributions are taxed as ordinary income. Depending on the beneficiary’s tax bracket, the tax bill could be astronomical. In order to employ tax-efficient measures, beneficiaries could strategically spread out those distributions. This luxury is no longer the case.

The elimination of the stretch provision states that all non-spouse beneficiaries (with a few notable exceptions) must take all distributions within 10 years of the account owner’s passing. There are no specific RMD requirements throughout those 10 years, so you can still make a plan to be as tax-efficient as possible, but beneficiaries of large IRAs will still be on the hook for large tax consequences.

Since many beneficiaries of inherited IRAs will be in their prime earning years, their tax brackets will be higher which means that the IRS will get a larger cut of the money. Tax-efficiency is one of the most important aspects of your financial plan which makes the elimination of the stretch provision so significant.

This rule goes into effect for all accounts on January 1, 2020, so if you inherited an IRA in 2019, the stretch rule can still be applied. You can still make use of the stretch provision in 2020 under a few different conditions:

Spousal beneficiary
Minor child (until they turn 18, then the 10-year rule goes into effect)
Disabled beneficiary
If the beneficiary is less than 10 years younger than the IRA owner

General rules beneficiaries need to know

The rules for spousal beneficiaries have all but remained the same. The IRS treats a sole spousal beneficiary in a unique way in that the beneficiary can take full ownership of the inherited account.

There are many options available to spousal beneficiaries upon the death of an IRA account holder like a spousal rollover, establishing an inherited IRA, or treat the inherited account as their own among others. Someone in this position should speak to their financial advisor to determine the best option for them.

It is not uncommon for someone to designate a trust as a beneficiary of their IRA. The trust may have been drafted for a myriad of reasons including limiting the amount of money that beneficiaries would receive, providing for younger beneficiaries, or just having more control over the distribution process of the inheritance.

The SECURE Act has instituted many new changes to how this process needs to be evaluated. Some common troubles in naming a trust as a beneficiary include see-though provisions, asset allocation in IRAs, asset protection from creditors, and more. Because of these changes, our team believes that all such trusts should be reviewed to determine if they are actually accomplishing the goals they originally intended.

Make your inheritance more impactful

Since the SECURE Act has likely changed the outcome of your inherited IRA strategy, now is a great time to seek additional ways to structure your IRA going forward. Talk with your Wealth & Trust Officer about the following questions:

Should you consider a Roth conversion now in order to avoid tax implications later?
Can you spend down IRA assets first and leave your family and loved ones non-IRA assets?
How can your charitable giving strategy change to better suit the economic climate? You can consider changing the specific assets you want to leave to charity and the vehicle you use to gift them.

All of these key points should be discussed with your financial advisor—and sooner rather than later. Remember, these rules apply to IRA's inherited from an account owner that passes away after December 31, 2019.

Here at First Dakota, our Wealth & Trust Officers are here to help you revise and update your estate plan to maximize your assets for generations to come. Our team is a resource you can trust as we manage over $75,000,000 in IRA assets alone. We are confident that we can help you devise a solution that works for you and your family.

We are here to answer your IRA questions, whether you are inheriting an IRA or planning for your own retirement. Ready to get started? Give us a call today.

First Dakota Wealth & Trust is the fiduciary investment department of First Dakota National Bank with trustee powers to serve clients during their lifetime, during incapacity, and after death. We help clients develop a financial roadmap to help simplify their financial future.

Please note that neither First Dakota National Bank nor First Dakota Wealth & Trust Department, or its employees provide tax or legal advice. This is intended for informational purposes and is not intended to constitute legal or tax advice. Please consult your attorney and/or tax professional for advice related to your specific situation.