The SECURE ACT took effect 1/1/2020: Will your family be affected?

When it comes to finding new ways to siphon more money out of middle-class taxpayers’ pockets, there is no shortage of great ideas on Capitol Hill.

Take the clumsily-titled Setting Every Community Up for Retirement Act (SECURE Act), for example. The SECURE Act, which became effective on January 1, 2020, has been called by some planners the “Extreme Death-Tax.” The Act is poised to do a lot of harm to the legacies of IRA-owners.

Many retirement planning experts and CPAs say that SECURE’s most important provision is a section that modifies the required minimum distribution (RMD) rules for inherited IRAs. This change essentially puts an end to a widely-used legacy-planning tool known as the “stretch IRA.”

With only a handful of exceptions, an IRA or retirement plan that a person inherits will now have to be distributed (and taxed) within ten years of the death of the original owner. Previously, a non-spouse beneficiary of an Inherited IRA was allowed by the IRS to minimize their tax bill from that inherited plan by limiting their required distributions to a smaller amount, depending on their age.

This technique was, in effect, “stretching” the Inherited IRA over the beneficiary’s lifetime. Stretching allowed the recipient to keep most of that IRA in a tax-deferred status as with traditional IRAs, or tax-free in the case of Roth IRAs. This rule applies to heirs of account holders who die starting in 2020.

The new rules now deprive IRA beneficiaries of potentially decades of tax-deferred or tax-free growth. SECURE also subjects beneficiaries of traditional, tax-deferred retirement plans to a rapid acceleration of income-tax.

It’s easy to imagine that this situation could be especially unkind to beneficiaries of inherited IRAs who are still working. Beneficiaries with their incomes could find that the added income from accelerated Inherited IRA withdrawals will cause them to be taxed at an even higher rate.

You can probably guess that the reason for the change in these rules is the US treasury’s need for money. This need for more revenue means that children and grandchildren of IRA owners will see large chunks of their inheritance taxed away. The result of these changes is $15.7 billion in additional tax revenue.

It’s important to note that a surviving spouse is not subject to the new provisions, nor are non-spousal heirs who are not more than ten years younger than the original IRA owner, for example, an owner’s sibling or unmarried partner. Chronically ill and disabled beneficiaries are also exempt from the Inherited IRA distribution provisions of the SECURE Act, as are minor children. However, once a minor beneficiary becomes an adult, their ten-year distribution clock starts ticking.

Whether you are the beneficiary of an Inherited IRA or you have an IRA and want to include it as part of the legacy you leave to loved ones, you need to speak with a financial professional as soon as possible. He or she can find solutions that will help you plan your legacy around these new rules.

If you are a beneficiary, strategies exist that help prevent you from making mistakes with your Inherited IRA and falling into a very unpleasant tax trap.

If either situation applies to you, be sure to consult your trusted advisor, CPA, or tax strategist as soon as possible. They’ll give you the guidance you need to stay one step ahead of the government’s attempts to pick your pockets.