While the SECURE Act (Setting Every Community Up for Retirement Enhancement Act of 2019) brought us many positive changes, there were a few negatives too, and clearly among the biggest was the end of the stretch IRA. The stretch IRA allowed a beneficiary to “stretch” the required withdrawals over their lifetimes instead of taking it out in a lump sum and incurring more taxes sooner. The stretch IRA is still available to beneficiaries who inherited an IRA in 2019. If you inherited an IRA after 2019, then the rules become more complicated.
The replacement to the stretch IRA is the 10-year rule. The 10-year rule applies to IRAs, 401k, 457, and 403b plans and Roth IRAs. Instead of having the classification of a “designated beneficiary”, we now have 3 classes of beneficiaries. These include:
1. Eligible designated beneficiaries — These beneficiaries are exempt from the 10-year rule.
• Surviving spouses
• Minor children
• Individuals less than 10 years younger than the original owner
• Chronically ill individuals
• Disabled individuals
Eligible designated beneficiaries are still subject to required minimum distributions (RMDs).
2. Noneligible designated beneficiaries — These are a class that is subject to the 10-year rule. As such, they are not eligible to stretch out payments over their lifetime like eligible designated beneficiaries are. These beneficiaries may include grandchildren, look-through trusts, etc. They do not have a required minimum distribution, unlike eligible designated beneficiaries. While the lack of RMDs is a good thing, the entire account balance must be distributed by the end of the 10th year. Just remember that waiting until the end of the 10th year in order to delay taxes isn’t always the best idea. If the account earns a little over 7% net per year (7.2% to be exact), then the account balance would be double what you inherited it at. So let’s assume you inherited a $100,000 IRA, it would now be worth $200,000 if you didn’t take any distributions and earned 7.2%. If you waited the 10 years in order to delay taxes, you now have to distribute out the entire account balance in 1 year and would end up owing ordinary income taxes on $200,000 of income which would be added to all of your other income that year. This might cause you to move into a higher income tax bracket and ultimately owe substantially more tax than you otherwise would if you had taken some out each year over the preceding 10 years.
3. Nondesignated beneficiaries — These beneficiaries include non-natural persons such as a charity, some trusts (non-look-through) or your estate. For nondesignated beneficiaries, there are 2 different rules depending on whether or not the person you inherited it from was taking their required minimum distributions (RMDs) or not.
• If they were taking their RMDs, then you are required to take the funds out over the original owner’s life expectancy based on their age at the date they passed away. The life expectancy is based on an actual table that the IRS publishes.
• If the original owner was not already taking their RMDs, then a nondesignated beneficiary must take out all of the funds by the end of the fifth year. They do not have to take RMDs, but the entire account value must be taken out by the end of the fifth year.
As you can see, there are a lot of complicated rules depending on factors related to both you and the original owner. If you inherit an IRA or other retirement plan, my advice is to not make any decisions regarding it until you speak with your advisor or CPA. It is too easy to make a mistake when making decisions regarding these plans, and unfortunately, many of those mistakes cannot be undone. If you have any questions, feel free to give us a call and we can help walk you through some of your options.
T. Eric Reich, CIMA, CFP, CLU, ChFC is president and founder of Reich Asset Management and can be reached at 609-486-5073 or firstname.lastname@example.org.
Securities offered through Kestra Investment Services, LLC (Kestra IS), member FINRA/SIPC. Investment advisory services offered through Kestra Advisory Services, LLC (Kestra AS), an affiliate of Kestra IS. Reich Asset Management, LLC is not affiliated with Kestra IS or Kestra AS. The opinions expressed in this commentary are those of the author and may not necessarily reflect those held by Kestra Investment Services, LLC or Kestra Advisory Services, LLC. This is for general information only and is not intended to provide specific investment advice or recommendations for any individual. It is suggested that you consult your financial professional, attorney, or tax adviser with regard to your individual situation.