Review your estate plan: New rules for inherited IRAs took effect Jan. 1, 2020
Making your Roth IRA or traditional IRA part of the inheritance in your trust and estate has new rules, and they mean big changes for your inheritors.
To be clear, the new rules under the SECURE Act apply only to people dying on or after Jan. 1, 2020. For deaths on or before Dec. 31, 2019, the old rules for Stretch IRAs still apply. However, it’s a good idea to review your estate plan in light of the new rules to see if any changes are still needed.
The end of the “stretch IRA?”
IRAs bequeathed in an estate used to be able to be “stretched.” Informally called a “stretch IRA,” it simply meant the beneficiary could take distributions and draw down the account throughout their lifetime. However, the new SECURE Act, passed in December 2019, means major changes ahead for anyone using IRAs as part of their estate.
As of Jan. 1, 2020, those old rules still apply to some beneficiaries and a limited set of circumstances. For all other beneficiaries, new rules require that inherited IRAs be depleted (and applicable taxes paid) within 10 years of receiving the bequest.
We’re going to walk through these big changes and what they might mean for your estate.
The SECURE Act changes how Stretch IRAs work
Under the SECURE Act, you can still bequeath traditional and Roth IRAs to any beneficiary of your choice. Here are the main things to be aware of and discuss with your estate planning attorney:
All funds in the account bequest must be distributed in full within 10 years of the death of the original account owner.
However, some beneficiaries, known as Eligible Designated Beneficiaries, or EDBs, as of Jan. 1, 2020, are not subject to the 10-year rule:
- The original account owner’s surviving spouse. A trustee-to-trustee IRA transfer confers ownership to your spouse.
- Minor children of the original account owner. Estate planning also needs to take into account once minor children reach majority age, however, as then the 10-year depletion rules go into effect.
- Disabled beneficiaries. An individual shall be considered to be disabled if he or she is unable to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment which can be expected to result in death or to be of long-continued and indefinite duration.
- Chronically ill beneficiaries. Any individual who has been certified by a licensed health care practitioner as: (i) being unable to perform (without substantial assistance from another individual) at least 2 activities of daily living for a period of at least 90 days due to a loss of functional capacity, (ii) having a level of disability similar (as determined under regulations prescribed by the Secretary (in consultation with the Secretary of Health and Human Services) to the level of disability described in clause (i), or (iii) requiring substantial supervision to protect such individual from threats to health and safety due to severe cognitive impairment.
- Beneficiaries up to 10 years younger than the original account owner, such as a sibling or a domestic partner you are not married to.
Only beneficiaries fitting the descriptions above are eligible to be EDBs. For example, EDBs do not include grandchildren, a sibling 11 years younger, or your best friend. Any non-EDB beneficiary must take distributions of all funds in the inherited IRA by Dec. 31 of the tenth year after the year of death.
Trusts are not immune to the SECURE Act
A trust is an excellent vehicle for managing bequests and investments to heirs and beneficiaries, but IRAs bequeathed to trusts will also be subject to the SECURE Act’s 10-year distribution rules unless the beneficiary qualifies as an EDB.
In order to determine if a trust qualities as an EDB, the trust must be a conduit trust or an accumulation trust. A conduit see-through trust means the trust language requires that all required minimum distributions collected from the IRA will pass through directly and immediately to the underlying income beneficiary. This may not be what you want, and if that’s the case then a trust amendment to the accumulation trust might be the best option.
Even though the trust will be paid out in 10 years in most situations, the terms of the trust would then be able to control how those funds are distributed.
Review and evaluate all IRAs, beneficiaries, trusts, and your estate plan
Regardless of how you have planned to have your IRA bequeathed in your estate plan, it’s important to contact your estate planning attorney for a thorough review of your IRAs, beneficiaries, trusts, and overall estate plan. Depending on your setup, options you and your attorney might consider include:
- Changing beneficiaries
- Modifying trust setups or creating a trust
- Converting traditional IRAs to Roth IRAs, as taxes will have already been paid on Roth funds
- Planning trusts around minor children reaching majority
- Tax payout considerations for the estate and beneficiaries
- Granting trust protectors power to change trust from a conduit to an accumulation or vica versa
It’s a great time of year to sit down with your estate planning attorney and discuss how to work with the SECURE Act’s requirements—and figure out the best way to help them work to the best interest of your estate.
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Disclaimer: All content in this post is provided solely for educational purposes. It is not legal advice.