2020 has been a difficult year for all of us, and on top of it, IRAs might now be the worst investment vehicle to inherit.
Okay… I am sorry for that clickbait lead in, but with all that has happened this year we couldn’t let this get lost in the sauce. On January 1st 2020 the SECURE Act (Answering Your Biggest Questions on the SECURE Act) went into effect and the act was seen by many as the biggest change to retirement planning in a generation.
The Act changes many things such as allowing contributions to retirement plans after 70 1/2, increasing the age for required minimum distributions but arguably the biggest impact was the removal of the “Stretch IRA”. Before 2020, beneficiaries who inherit a retirement account had the option to “stretch” their distributions, allowing them to take it based upon their life expectancy. Now they must exhaust the account in 10 years or less.
So, while taking large sums of money quickly might not seem like a curse, the downside is their tax treatment is the same is yours; every dollar they withdraw from the account is treated as taxable income. This decade long increase in income could wreak havoc on your beneficiary’s tax situation and end up leaving more money to Uncle Sam than anyone would prefer. There are a few techniques to potentially help mitigate this problem by using IRA dollars to fund other inheritance strategies.
Gifting
The easiest and most basic way to bypass the new 10-year rule is to just gift the money. You are able to gift up to $15,000 a year to as many individuals as you would like without incurring any federal gift tax consequences. In this case you would avoid having your beneficiaries pay income tax by giving it to them before you pass, but there are some drawbacks. Withdrawing that money from your IRA would be taxable to you and gifting it would mean you would lose control over those funds.
Roth Conversions
A Roth conversion is where you transfer funds from a Traditional IRA to a Roth IRA and pay taxes on the full amount transferred. While you do have to pay those taxes up front, the benefit on the backend can be numerous. Roth IRAs have a different tax structure than Traditional IRAs; money that goes into a Roth cannot be deducted from income, but it grows tax free and distributions can be tax free. This means that while you’re alive that money is still yours should you need it, but your beneficiaries could potentially withdraw their inheritance tax free.
Qualified Charitable Distribution
A Qualified Charitable Distribution or QCD is a distribution from an IRA made payable to a 501(c)(3) qualified charity. You are able to make as many QCDs as you’d like a year as long as the sum totals $100,000 or less. QCDs allow you to continue to make charitable contributions, but by taking it from your IRA you’re able to make a tax-free distribution.
So, while inheriting IRAs might not be as terrible as Uncle Kevin’s toupee, they really are not as favorable as they used to be. Depending on your goals and tax situation one or more of these strategies might be a great way to help your beneficiaries receive their inheritance as you intend.