The Secure Act, which was made into law in late 2019 and effective for deaths after 2020, has a significant impact on estate planning and how quickly your named beneficiary will have to pay income tax on the distributions from your IRA, 401k, and any other tax-deferred retirement accounts.
As you might have guessed, it will have a negative impact on your child/grandchild/beneficiary and a significant positive impact on the Government.
Prior law – Under the previous law, if your 50-year-old beneficiary inherited your IRA, he or she would be allowed to take annual required minimum distributions over 34.2 years (the beneficiary’s remaining life expectancy). This process was known as a stretch-out. The stretch-out permitted the IRA to remain in a tax-deferred account until distributed, for the life expectancy of a beneficiary.
New Law (Secure Act) – Under the Secure Act, your beneficiary will have to take the IRA out within ten years, in full. This does not change the current Estate Tax standards.
Now, instead of paying tax over 34.2 years, a beneficiary will pay all of the tax in ten years. Let’s say you have one child and $1 million in an IRA; at your death, your child will have to add an extra $100,000/year to their taxable income for ten years. This change will push nearly all beneficiaries into a higher tax bracket.
Who needs to take action?
Generally, for anyone with an IRA, 401(k), or another tax-deferred retirement account beyond $500,000, something should be done if you want to limit income taxes for your beneficiaries. Based on this new law, your current trust and estate plan will need to be modified to fit within the new legal structure.
What can be done?
There are ways to offset this change in the law. Generally, options include:
- creating a charitable remainder trust;
- allowing distributions to both children and grandchildren, thereby moving income taxes into lower tax brackets;
- converting to a Roth IRA; or
- purchasing life insurance to offset the increased taxes.
In all cases, these updates will likely lead to a modification in your current estate plan.