In December 2019, Congress passed the Setting Every Community Up for Retirement Enhancement, otherwise known as the SECURE Act. This legislation seeks to simplify and broaden access to retirement savings for many Americans. Since its passage, the SECURE Act has already seen important clarifications and updates that need to be reviewed carefully. Just like any piece of legislation, it’s important to take a close look at how the specific policies will impact your unique retirement.
One of the ways that the SECURE Act can impact your retirement savings is through regulations on inheriting IRAs.
Before the enactment of the SECURE Act, those inheriting IRAs or 401(k)s could typically use a “stretch” strategy, allowing them to take taxable distributions and tax payments over the span of their lifetime. Many people relied on these “stretch” accounts as a dependable source of lifetime income.
However, for IRAs inherited from original owners who passed away on or after January 1, 2020, the new law mandates that most beneficiaries withdraw assets from an inherited IRA or 401(k) plan within ten years after the account holder’s passing. The regulations, published February 24, 2022, further specify that a complete distribution must take place by the tenth year, provided that the deceased had already started required minimum distributions (RMDs). (1)
Please keep in mind that some exceptions apply:
-Spousal Beneficiaries: Individuals inheriting an IRA or 401(k) from their spouse can still stretch out their required minimum distributions (RMDs) over their lifetime. The SECURE 2.0 Act, enacted in December 2022, expanded this benefit for spousal beneficiaries, allowing them to opt for this approach.
-Eligible Designated Beneficiaries (EDBs): Certain individuals may also qualify for distribution stretching, including children of the original owner who are minors (not grandchildren), individuals less than ten years younger than the original owner, and those classified as disabled or chronically ill as per the Internal Revenue Code.
If you do not fall into the spousal or EDB categories, you are required to distribute all assets from the inherited IRA within ten years of the original owner’s passing. Your approach to this should be tailored to your specific circumstances.
Here are three scenarios to consider:
Scenario 1: Inherit a Traditional IRA or 401(k), if you need income for retirement and you expect a stable tax status.
- Withdrawal Strategy: Opt for equal installments over the ten-year period to manage taxable income levels effectively.
- Investment Strategy: Consider investing the inherited account conservatively, keeping more aggressive investments in non-inherited retirement accounts, to potentially lower your total tax bill.
Scenario 2: Inherit a Roth IRA or Roth 401(k) if you expect a stable tax status.
- Withdrawal Strategy: Maintain assets in inherited Roth accounts for as long as possible to maximize tax-free qualified withdrawals.
- Investment Strategy: Potentially invest the inherited account aggressively, reserving more conservative investments for other non-Roth assets, minimizing your overall tax liability.
Scenario 3: Inherit a Roth Account if you anticipate tax changes.
- Withdrawal Strategy: Consider irregular withdrawals over the ten-year period to even out taxable income and tax liability, especially if you anticipate changes in your tax status or income.
- Investment Strategy: As in Scenario 2, you may opt for more aggressive investments in the inherited account and conservative ones for non-Roth assets.
Remember, these scenarios simply serve as general guidelines.
The best course of action is to consult a financial planner who can help customize your approach based on your unique financial situation and retirement goals. To talk more about this and understand your unique situation, schedule time to chat with a financial planner at The Retirement Solution.
Investment advisory services and insurance services are provided through The Retirement Solution LLC., a Registered Investment Advisor. The information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities product, service, or investment strategy. Investments involve risk and unless otherwise stated, are not guaranteed. There is no guarantee that the strategies discussed will be successful. Be sure to first consult with a qualified financial adviser, tax professional, or attorney before implementing any strategy or recommendation discussed herein.