Planning out an estate properly relies, largely, on portioning out and understanding the wealth you already have. If that wealth happens to be in an IRA in some part or another, there are some changes going around that almost certainly pertain to you and anyone you plan on inheriting from you. As with any major change, it’s important to know the whole story about how and why they’re making a change and how it’s going to affect you. This ensures you’ll be able to make the right decisions about your estate plan and protect your wealth for future generations. At Goldberg & Associates, we’re happy to help you stay in the loop on your wealth management and keeping your estate plan locked down tight to avoid future charges and strife for the people who pose to inherit. That’s why we’re always working to gather more information to make your decision-making process more easily supported.
The Secure Act
Last year, the Senate passed a new government spending legislation that controls how people’s savings and retirement would be affected. It made it easier for employers to add annuities, or a fixed sum of money that’s paid to someone each year, as well as expand the options within a 401(k) retirement plan. It made room for people to be able to continue contributing to their retirement after the age of 70 and made it easier for part-time employees to start contributing to their retirement early. The idea behind this act was that there’s a pattern slowly forming around the country of people putting off retirement as long as possible. The hope was that allowing people to save and earn longer, they’ll be able to decrease the number of people working far into their 70s, rather than retiring from the workforce and opening up new positions for younger citizens.
The changes that are being made to your IRA now are in effect because of the Secure Act from 2019. With so many people living and working longer, it’s important to include a supportive nest egg for the citizens that pertains to. However, just because lots of rules were eased or even thrown away in regard to IRAs, there are a few new rules that are put in place now to restrict how IRAs can function. One of the main restrictions will be placed on how IRAs are inherited or bequeathed.
The Rules Before
Before this legislation passed, anyone who inherited an IRA or any form of retirement account simply had to take some money out of it every year. If you wanted, you would be able to stretch out these withdrawals over an entire lifetime. You could even withdraw very small amounts each year to lessen the burden on your income taxes and keep the current balance invested and hopefully earning more money. This helped IRAs last for nearly two generations and was a major boon for some families. After all, if you don’t have much to give those who pose to inherit from you, you could pass along a nice amount in an IRA that would be there for them to bolster their own retirement funds. However, that’s not the case anymore. Now, your heirs will only have around 10 years to drain the account. This is due to the nature of the old accounts being tax-deferred for so long. This left lots of wealth outside of the taxable range of the government, which is why it was recently addressed.
The New Rules
If you inherit an IRA at this point, you’ll need it emptied and all the taxes paid on those payouts within 10 years of gaining access to it, or the account passing hands. The reason this can be difficult is two-fold. First, you’ll have to pay taxes earlier and you’ll be restricted in how much the account can really earn. Second, you’ll have to add the income from the IRA to your current income. If you inherit an IRA and you’re at the top of your tax bracket, once you start pulling money from the IRA, you’ll be pushed into the next income tax bracket and likely end up paying much more for the money than you would have if you could have accessed the money during retirement when you aren’t earning as much.
The Exceptions to the Rule
However, there’s still good news, the stretching technique isn’t going to be thrown out entirely. For example, a spouse could still inherit an IRA and continue to stretch out their withdrawals for some time. Plus, if you’re a child that inherits, you can do this from age 18 to 21, too. For some other special cases, this method is still allowed. For example, people who have disabilities or very serious chronic illnesses that are passed their inheritance in the form of an IRA to keep it simple won’t have to abide by the 10-year withdrawal rule. In addition to that, if a beneficiary is less than 10 years younger than the original account owner, you could still stretch the IRA.
403(b) and 457(b) accounts are exempt from this until 2022. These plans are often only available to government and nonprofit workers. If someone was going to inherit one of these accounts within the next couple of years, that individual would still be able to stretch those accounts into the future. However, for IRAs and Roth IRAs, as well as 401(k)s the new rules go into effect as of 12.31.2020.
The Up Side
In all of this rearranging of IRA rules, one good thing did come of it and that’s the abolition of the minimum withdrawal amounts. Rather than be required to remove money from the IRA at a certain amount every year, you can now withdraw from the account at whatever time you want and whatever amount you’d like. If you’d like, you can even simply remove the entire sum at the end of the 10-year period, too.
What Can Be Done About the Restrictions?
If you’re someone that would still like to leave a burgeoning IRA account to your heirs, you have options. Even if your heirs don’t qualify for one of the pre-stated exceptions, you still have more options than what may initially seem evident.
At this point, you could convert your regular IRA into a Roth IRA. That way, your money would be contributed to after-tax, so when your heirs withdraw they won’t have to pay taxes on the money if they follow a certain set of rules during the withdrawal process. You would owe taxes now on the money, but your heirs would not. If you’d like, you could divide the IRA among several different beneficiaries which would decrease the amount of money owed overall to the government as each would be earning less initially.
Trusts Might Get Tricky
The other roadblock folks looking to pass down an IRA account might face is if they’re wrapping the IRA up in a trust for grandchildren or children. IN general, trusts can be used to carefully direct funds and ensure that funds won’t be mismanaged and fretted away after you pass. They can also protect your heirs from divorce and liabilities of all kinds, which might be attractive to some individuals depending on the current status of the heir. One major benefit of this method, however, is that trusts can still be eligible for IRA stretching. You’ll need a certain kind of trust to qualify, but it can be done. A conduit trust, for example, immediately funnels the required withdraws from the IRA into the trust’s beneficiary. This would ensure that the beneficiaries of your estate pay taxes in their own bracket on the money they receive from the trust. However, the trust will have to pay all of that money out within 10 years, which is often an issue with families who establish trusts, as there is some concern about a beneficiary blowing the money away, and that big payout would be inevitable despite the trust being place thanks to this new law.
However, discretionary trusts or “accumulation” trusts could be a safer option. That would allow the required IRA withdraws to occur, but it would remain in the trust and grow. You’d be able to assign a trustee who could dole out the funds beyond the 10-year span allowing you to keep the payments coming for a pretty long time so your heirs could use it for their retirement. However, holding onto the money for longer will almost certainly ensure a larger tax bill. Trust funds are typically taxed at a much higher rate anyway, making this strategy only work for a select few.
If you’re exploring options to help you pass on your IRA more completely and without it being unnecessarily taxed, reach out to us. We’re always happy to help you rearrange your estate plan to suit your current needs and the needs of your beneficiaries. Here in Atlanta, we honor and respect the family values that make the Southern culture so hospitable and memorable. Ensure that you’re preserving your family’s comfort and your own family values by scheduling a consultation with us. Together, we’ll help you determine what the right choices are to help your heirs long after you’re gone.