Inherited IRAs – No Longer the Bargain They Used To Be

Author – Kristen Terranova

Planning to leave your retirement accounts to your kids or grandkids? It may be time to revisit your estate plan.

For decades one of the key tools in estate planning was to build up wealth in tax-favored retirement plans, which could then be passed on to the original owner’s descendants. Known as the “stretch IRA,” these inherited accounts could remain invested for the child’s lifetime, with the schedule of required withdrawals recalculated using the child’s life expectancy instead of the life expectancy of the original owner. Hence, a child could “stretch” out the period of time that the assets could stay in the account, growing, while delaying the time when taxes on that growth would be paid. Taxes delayed meant money saved.

In estate plans where a significant part of the person’s wealth was held in retirement accounts, it was common to pair the stretch IRA with another estate planning tool, the lifetime trust. By directing the IRA to be paid to their living trust after their death, plan owners could have greater control over how the IRA funds were distributed to their children or other beneficiaries.  

All that has changed with the enactment of the SECURE Act. Beginning in January 2020, the SECURE Act ends the lifetime stretch option for most people. In its place are new rules requiring the inherited assets to be entirely withdrawn from the IRA within 10 years of the original owner’s death. This compressed timeline means beneficiaries will have to withdraw more, giving them more taxable income. Some individuals may be able to strategize with their tax professionals to mitigate this impact. Still, the overall effect is that income taxes will take a bigger bite out of inherited retirement accounts than the original owner may have planned. 

For estate plans that direct IRAs into lifetime trusts, the impact is magnified. While trusts can still hold retirement assets, the 10-year withdrawal rule applies here as well. Rapidly withdrawing all of the IRA can result in trapping income at trust tax rates, which are typically much higher than individual rates. Or, it can force the Trustee to distribute large sums to the trust beneficiaries. For those who set up trusts in order to avoid putting too much cash into the hands of a minor or imprudent beneficiary, this change to their estate plan may be troublesome.   

Limited exceptions to the 10-year rule exist for the following groups:

  • Spouses
  • Minor children
  • Disabled or chronically ill individuals
  • Beneficiaries who are less than ten years younger than the original owner (e.g., siblings, unmarried partners)

However, it is important to note that once a minor child attains majority (with some extensions while still in college), the 10-year clock starts running to withdraw the inherited IRA assets.

The benefits of inherited IRAs may have shrunk, but there are still options to counteract these changes within a complete estate plan that considers all of your assets and goals. Your estate planning attorney, working with your financial advisors, can help you consider whether to:

  • Change your trust terms
  • Reallocate retirement and non-retirement assets between beneficiaries who can use them most optimally
  • Put less of your savings into retirement plans or convert to a Roth IRA
  • Arrange to spend retirement assets more quickly than other assets
  • Use a charitable trust to extend gifts to children while benefiting charity
  • Plan for payment of anticipated taxes on retirement assets 

Want to learn more about how the SECURE Act affects your estate plan? The expert estate planning attorneys at Deka Law Group are here to advise you. Call us at 626-765-6272.   

By Kristen Terranova

Serving Southern California, including Pasadena, La Canada, Glendale, Burbank, Calabasas, Westlake Village, Thousand Oaks, Simi Valley, Camarillo and beyond.