The SECURE Act, effective January 1, 2020, has ended the Stretch IRA for most adult non-spouse beneficiaries. The motivation clear and simple is more Tax Revenue for Uncle Sam. The change from Life Expectancy Distributions to the Ten Year Rule is estimated by the Congressional Research Service to bring in to the federal coffers $15.7 Billion in fiscal years 2019 to 2029.
When a taxpayer dies with money in an IRA, that money is subject to income tax when distributed. Beneficiaries will owe the tax based on their own tax bracket when they withdraw money from the IRA.
For IRAs inherited prior to January 1, 2020, the old rule still applies. If you inherited an IRA before January 1, 2020, you are still allowed to Stretch IRA distributions over your life expectancy. A Designated non-spouse beneficiary may take minimum distributions from an Inherited IRA spread over his or her life expectancy under the Pre-2020 Rules. This often could be an adult child or a grandchild of the original IRA owner.
The Life Expectancy Rule, referred to as a Stretch IRA continues the tax deferral for many years after the IRA owner’s death. It grants beneficiaries a lot of latitude regarding when to receive distributions and pay the tax as long as they take the required minimum distribution annually. This rule “stretches” the Inherited IRA over the beneficiary’s life expectancy and so has been called a Stretch IRA.
When a taxpayer dies on or after January 1, 2020, new rules apply for Designated non-spouse beneficiaries. The new rule is called the Ten Year Rule. All funds in the IRA must be distributed by the end of the 10th year after the death of the IRA owner. There are no Required Minimum Distributions in years 1 – 9. The beneficiary has 10 years (instead of life expectancy) during which to take distributions and each distribution is taxable at the beneficiary’s ordinary income tax rates. The beneficiary may take distributions of any amount during the 10 years as long as the final distribution is taken by December 31st of the 10th year following the year of the IRA owner’s death.
This change both accelerates and increases the potential income tax that will be paid thereby reducing the net to the Beneficiary. When adult children inherit their parents’ IRAs they may still be employed and the Ten Year Rule forces this income out and it is added on top of their earned income. It could potentially be taxed at a top tax bracket.
The rule for spousal beneficiaries is unchanged under the SECURE Act. A spouse may rollover the IRA to his or her own IRA or stretch distributions in an Inherited IRA over life expectancy.
There are four exceptions to the Ten Year Rule in addition to a spouse. Minor children of the deceased IRA owner until age of majority, disabled beneficiaries, chronically ill beneficiaries and beneficiaries within ten years of the age of the deceased beneficiary may still use the Life Expectancy Rule and Stretch an Inherited IRA.
Written by Connie C. Guelich, CFP, AEP, CLU, ChFC. This represents our view at the time of this writing and is subject to change. This is not intended to be personal investment advice. If you would like to discuss your own account, please don’t hesitate to call us. We are here to help and welcome your call.