How to Handle IRA Beneficiaries Under the SECURE Act

Phil: Welcome to another one of our Tull Financial Group Financial Fridays where we give you a tidbit of information to help educate you on all the things out there in the world that have to do with your finances and I know right now people are asking about the American Rescue Act that is being passed this week. There’s a lot to that stimulus bill – 1.9 trillion in stimulus relief as well as some different tax adjustments that they’re making – so we’re going to be reading through that to educate ourselves so we can equip you all in the coming weeks, so stay tuned as we will be coming out with more information on that.

We are about a year out from the SECURE Act that was passed in the beginning of 2020, so we want to give you more insight on the topic of inherited IRAs that changed which was treated differently in 2019 than in 2020 and now effective in 2021. Unfortunately, there was a lot of loss in 2020 and so this is a reality that people are having to deal with, these inherited assets that are coming down from the parents or grandparents. So, can you just give us an overview of maybe how they were and now what it looks like in terms of those changes with the SECURE Act?

Robin: Sure Phil, for years we shared with clients this term called the stretch IRA and what the process with the stretch IRA was. Let’s say, for example, you had a parent and that parent named you as a beneficiary of their IRA and when they passed, you had the freedom to take the distributions out over your lifetime, which was a significant tax benefit for people. With the SECURE Act, that restricted that option for many people. It is still available for the spouse – what they’re calling it now is called “EDB” or eligible designated beneficiaries and you might ask who are those people? They are a surviving spouse, minor child, disabled person, chronically ill person, those are the eligible designated beneficiaries that still have that ability to stretch out the payout over their lifetimes.

Phil: What about those non-eligible beneficiaries that are getting this money? So, the kids maybe or other individuals may be a cousin or family member, an extended family member. How would they be treated with this new 10-year rule?

Robin: The designated beneficiary is all others and there’s this 10-year rule now that they have and it means simply that if you are the beneficiary of an IRA, you have within 10 years to take the distribution. It really behooves you to get with your financial advisor or tax planner to discuss that because you want to take that out in that lower tax year. Yes, you don’t have to take it out until the end, but it does have to be taken out within that 10 years.

Phil: It sounds like there’s a lot of different options within those 10 years so you could take it in a lump sum at the beginning or one at the end. I think it’s important to know as well that those don’t have to begin until the year after, and then you’re able to space it out however you like.

Robin: That’s true. We found though that people will say “Well hey, is this a greater opportunity for doing a Roth conversion?” Which we here at Tull financial do a lot of those for folks, we do the analysis and get the in depth tax planning. The term they use is “rush to ROTH” because of this, but you still have to do that planning because if your tax bracket will be less than when you start taking out that traditional IRA then a Roth may not make sense. You really have to do that calculation from that standpoint.

Phil: I like that term “rush to ROTH” – you hear that a lot with people. They hear this Roth conversion and they think it applies to everyone, but from what I’m hearing from you it doesn’t apply to everyone. What’s a situation where it may not be a good idea?

Robin: We’ve done the planning for a lot of people in this particular area and when we say “Well, you’ve got to write a check to the IRS” that’s usually where there’s pause. But if the cash is available to do that and then they could be at a higher bracket later on, then the Roth conversion can work for some people. I think the longer that period of time, or the younger the person is, the better that option can be for them.

Phil: And then what about for beneficiaries because some people think “OK I’m going to go ahead and do this Roth conversion so then my beneficiaries don’t have to.” Is that always a good idea?

Robin: When you name them the beneficiary with the new rule and then what happens is when that person receives that money you know they do have to take it out within 10 years but remember the Roth it’s not taxable, but they simply have to take it out in that time period.

Phil: I know the last aspect we wanted to hit on was trusts, how do trusts play into this?

Robin: Before you start of course you want to see your legal counsel in this because so much has been set up in the past with conduit trust and accumulation trust. Accumulation trust is for children with special needs, there is some tax implications there with this 10 year suddenly becoming now taxable – you could be taxed at that higher bracket of a trust versus an individual, so I encourage folks with conduit trusts out there or accumulation trust – get with your tax counsel to get that planning done quickly.

Phil: There are so many complexities in this and that is why you have those professionals because they educate themselves and stay ahead of these things and read up on it. The new bill is 500 pages, right, so there is a lot to be said about those professionals that are educating themselves with all the details and idiosyncrasies. Anything else you want to add?

Robin: Just remember, planning is so important, and we found this in the last few years as people are looking to retire or transition, you really need to get with your tax preparer, get with your financial advisor. The streams of income, the drawdown – it’s so important that you consider the tax planning part of that whether it’s when you take Social Security, when you take your pension, and when you draw down from your IRA – it is so important to get with your advisor so we encourage people to do that.

Phil: Thank you, Robin, it’s been great for you to share with us. If you have any follow up questions, we encourage you to reach out to your advisor, your tax professional, your attorney for trusts, and really utilize those professionals.

We welcome the opportunity to serve you as well, so feel free to reach out, get in touch, and give us a call at 757-436-1122.