If you’re going to be putting your estate plan in place soon, you obviously care about things like making sure that your assets go to those who need or can benefit from them the most and helping to ensure that your beneficiaries’ inheritances aren’t unnecessarily minimized by taxes.
This is why you have to be careful about who inherits your individual retirement accounts (IRAs). For some beneficiaries, these assets can be a crucial part of their financial security after you’re gone. For others, they could be a significant tax burden. Let’s look at why that is and what you can do about it.
The SECURE Act
The Setting Every Community Up for Retirement Enhancement (SECURE) Act, enacted in 2019, changed the regulations around inherited IRAs and how long various beneficiaries have to take distributions on them. IRA distributions (even on inherited IRAs) are considered taxable income. Therefore, if you leave someone a sizable IRA or portion of one, they’d generally want to avoid accessing a good chunk of that money right away, as it could easily put them in a higher tax bracket.
Prior to the SECURE Act, IRA beneficiaries were given their estimated life expectancy (based on IRS rules) to take full distribution. Now, only “eligible designated beneficiaries” have that latitude. Other beneficiaries have to take the full distribution within ten years of inheriting the money. That can have a substantial impact on their taxable income if it’s a six- or seven-figure IRA.
Who are eligible designated beneficiaries?
The idea behind the change in the law is that those close to and dependent on the deceased are more likely to need their IRA inheritance for long-term financial support – potentially for the rest of their lives. Under the law, eligible designated beneficiaries include:
- Surviving spouses
- Minor children (until they reach legal adulthood)
- Individuals (related or not) who are disabled or chronically ill (or trusts set up for them)
- Any other beneficiary who’s less than ten years younger than the deceased
Since any of these beneficiaries have more freedom to take distributions as they need them (although they’re still considerable taxable income), you may want to leave them your IRA assets and bequeath other types of assets to those who don’t qualify as eligible designated beneficiaries – for example, adult children or non-profit organizations.
By having experienced legal guidance, you can better ensure that you fulfill your estate planning goals and that your assets are an enhancement to the lives of those you care about rather than a burden.