SECURE Act and IRAs in Estate Planning

The Setting Every Community Up for Retirement Enhancement (SECURE) Act, enacted in December 2019, introduced significant changes to the rules governing distributions from Individual Retirement Accounts (IRAs), particularly in the context of estate planning. Understanding these changes is essential for individuals aiming to incorporate IRAs effectively into their estate plans.

 

Key Changes Under the SECURE Act

 

Before the SECURE Act, IRA beneficiaries, such as children or grandchildren, could often "stretch" required minimum distributions (RMDs) over their lifetimes. This strategy allowed beneficiaries to spread out tax liabilities and maximize the growth potential of inherited IRA assets.

The SECURE Act replaced this "stretch IRA" provision with a 10-year distribution rule for most non-spouse beneficiaries. Here’s how the key changes impact IRA distributions and estate planning:

 

1. 10-Year Distribution Rule

 

Under the SECURE Act, most non-spouse beneficiaries must withdraw the entire balance of an inherited IRA within 10 years of the account owner's death. Unlike the previous system of annual RMDs, beneficiaries can choose when and how much to withdraw during the 10-year period, but the account must be fully liquidated by the end of the 10th year.

 

Impact on Estate Planning: The accelerated distribution schedule often leads to higher taxable income during the 10-year period, especially for beneficiaries in higher tax brackets. Estate plans relying on tax-deferred growth over a beneficiary’s lifetime now need revisiting to address this compressed timeline.

 

2. Exceptions to the 10-Year Rule

 

The SECURE Act provides exceptions to the 10-year rule for certain Eligible Designated Beneficiaries (EDBs). These include:

 

Spouses of the deceased account holder.

 

Minor children of the account holder (the 10-year rule applies once the child reaches the age of majority).

 

Disabled or chronically ill individuals.

Beneficiaries not more than 10 years younger than the deceased account holder.

 

Impact on Estate Planning: For EDBs, the traditional "stretch" distribution options remain, allowing some beneficiaries to spread distributions over their lifetimes. For others, particularly minor children, estate plans must anticipate the transition to the 10-year rule once the child reaches adulthood.

 

3. Roth IRAs and the SECURE Act

 

Roth IRAs, which grow tax-free and are not subject to RMDs during the account holder’s lifetime, remain an attractive estate planning tool. However, the 10-year distribution rule applies to Roth IRAs inherited by non-EDBs. Beneficiaries must still withdraw the funds within 10 years, but distributions remain tax-free.

 

Impact on Estate Planning: The 10-year rule diminishes the long-term tax-free growth potential of inherited Roth IRAs. Account holders may consider strategies such as Roth IRA conversions during their lifetime to reduce the tax burden on their heirs.

 

 

Strategies to Mitigate the SECURE Act’s Impact

 

To address the challenges posed by the SECURE Act, account holders may incorporate the following strategies into their estate plans:

 

Roth IRA Conversions: Converting traditional IRAs to Roth IRAs can reduce future tax liabilities for beneficiaries, as they will inherit tax-free distributions, albeit within 10 years.

 

Charitable Remainder Trusts (CRTs): Using CRTs can replicate the benefits of a stretch IRA by providing beneficiaries with annual income distributions over their lifetimes, with the remainder passing to charity. This strategy can help mitigate the tax impact of the 10-year rule.

 

Life Insurance Policies: Funding life insurance policies with IRA distributions can provide tax-free death benefits to heirs, bypassing the complexities of the 10-year rule.

 

Accelerated Giving: Account holders may consider gifting assets during their lifetime to reduce the size of their estate and provide direct support to beneficiaries.

 

Conclusion

 

The SECURE Act's changes to IRA distribution rules significantly impact estate planning strategies. While the elimination of the stretch IRA limits tax deferral opportunities for non-spouse beneficiaries, there are proactive steps account holders can take to minimize tax liabilities and achieve their estate planning goals. Consulting with financial advisors and estate planning professionals is essential to navigate these changes effectively and optimize the transfer of wealth to future generations.