The Setting Every Community Up for Retirement Enhancement (SECURE) Act fundamentally changed the rules governing distributions from inherited retirement accounts. Inheriting an IRA or 401(k) under the new administration could create several adverse tax consequences for the beneficiary—and it’s never too early to take actions designed to ensure the best possible outcome from a tax perspective.
Under the SECURE Act, nearly every beneficiary who inherits a retirement account (IRAs, 401(k)s, etc.) in 2020 and beyond will have to empty the account within ten years—and pay income tax on the distribution at ordinary income tax rates. (NOTE: Eligible designated beneficiaries (EDBs) include spouses, disabled and chronically ill beneficiaries, minor children of the account owner, and beneficiaries less than ten years younger than the owner). EDBs are exempt from the new rules and can continue to withdrawal from the inherited account and pay the taxes over their own life expectancy.
Consequences of the 10-Year Rule
- The penalty for noncompliance. Although the beneficiary can use discretion in determining when to take distributions within the 10-year time frame, if the beneficiary fails to empty the account within ten years, the IRS imposes a 50% penalty on the amount remaining in the account.
- The increased tax bracket. Every distribution will increase the beneficiary’s taxable income for the year. This creates the possibility that the beneficiary could jump into a higher tax bracket.
- Increased taxable income affects Medicare premiums. Income-based surcharges are added onto the base Medicare premium for taxpayers with higher incomes. Because an inherited account distribution increases taxable income, it can also cause the recipient to become subject to the surcharges.
Potential Solutions
- Every beneficiary should examine their tax picture in determining the best course of action when it comes to distributions within the 10-year window.
- Current account owners should take action to minimize the tax implications for their beneficiaries. Owners with multiple heirs may wish to leave the traditional retirement account to someone who qualifies as an EDB or who’s in a lower income tax bracket.
- For many account owners, executing a Roth conversion strategy can add flexibility and minimize the amounts in traditional retirement accounts. Roth IRAs aren’t subject to the new 10-year distribution rule and distributions aren’t counted as taxable income when the beneficiary eventually withdraws the funds.
Planning is complex under the SECURE Act but shouldn’t get in the way of your retirement and investment planning. We’re here to help, so call us today at (540) 720-5656, and let’s review your options.
Adapted from Think Advisor1
Megan Jones joined the ILG Financial team in 2020 as marketing director. Megan and her husband live in Fredericksburg, VA with their German Short Haired Pointer, Gus. Megan is a graduate of Longwood University and holds a degree in communications. Megan is the oldest of Dave Lopez’s three children and not only enjoys working alongside her father, but also with her cousin, Chase, who joined the ILG Financial team in 2020 as an advisor. Megan is also a fully licensed Life, Health, and Annuity agent. When not at work, Megan enjoys sitting on the back porch with family and friends enjoying food and music.
Amy Anderson joined the ILG Financial team in 2023 as the client relations coordinator. Her responsibilities include scheduling of appointments, annual check-up notifications, and annuity and required minimum distribution assistance. She is a graduate of Harding University with a degree in Computer Information Systems. Amy and her husband have two children and she enjoys reading, crocheting, music and spending time with her family.
Terri Center joined the ILG Financial team in 2019 as client services manager. She handles client records, application processing, and gathering information to provide a professional and friendly experience with all of our clients. Terri is a graduate of Oakland University. She is married and has two children. She enjoys hiking, family time, and puzzle challenging video games. She also likes to share her creativity in her canvas paintings and sewing projects.
Jessica Carson joined the ILG Financial team in 2018 as an agent. Jessica and her husband have four children, two dogs, 3 barn cats, 5 chickens, and three parakeets. She indeed loves her children and pets! When not at work, Jessica enjoys playing the piano and cello as well as traveling and spending time outside with her family, hiking, fishing, and boating.
Chase Lopez joined the ILG Financial team in 2020 as an advisor. Chase is a 2016 James Madison University graduate with a degree in management. Chase has been trained under the tutelage of Dave Lopez, who is not only the founder and managing member of ILG Financial, but also is Chase’s uncle and godfather. He also enjoys working alongside his cousin, Megan, who is Dave’s daughter.