Inheritance Rules

The SECURE Act was enacted in December 2019, and many of its provisions became effective starting in 2020. One provision in this legislation effectively eliminated the “stretch IRA,” an estate-planning strategy that allowed beneficiaries of IRAs and retirement plans to continue benefiting from tax-deferred growth, potentially for decades. Most non-spouse beneficiaries, including children and grandchildren, can no longer “stretch” distributions over their lifetimes. Individuals who plan to leave IRA and retirement plan assets to heirs — and individuals who stand to inherit retirement assets — should understand the new rules.

For deaths of IRA owners and retirement plan participants occurring before 2020, beneficiaries were generally allowed to stretch out the tax-deferral advantages of the IRA, or retirement plan, by taking distributions over the beneficiary’s lifetime. This ability to “stretch” taxable distributions over a lifetime helped reduce the beneficiary’s annual tax burden and allowed the investments in the account to continue receiving tax-deferred growth.

However, for deaths of IRA owners and retirement plan participants beginning in 2020, distributions to most non-spouse beneficiaries are generally required to be distributed within ten years following the IRA owner’s or retirement plan participant’s death. So, for those beneficiaries, the “stretching” strategy is no longer allowed. This shorter distribution period could result in unanticipated and potentially large tax bills for non-spouse beneficiaries. Also, any funds not liquidated by the 10-year deadline will be subject to a 50% penalty tax.
Exceptions to the 10-year rule are allowed for distributions to:

  1. the surviving spouse of the IRA owner or retirement plan participant;
  2. a minor child of the IRA owner or retirement plan participant;
  3. a beneficiary who is disabled or chronically ill; and
  4. any other beneficiary who is not more than ten years younger than the IRA owner or retirement plan participant.

A beneficiary who qualifies under one of these exceptions may generally still take distributions over his/her lifetime. However, the 10-year distribution rule will apply to a minor child beneficiary once that child reaches the age of majority (18 in most states). Spousal beneficiaries can roll over IRA or retirement plan assets to their own IRAs or elect to treat a deceased account owner’s IRA as their own.

Individuals often use trusts to manage the distribution of inherited IRA assets. Trusts can protect the assets from creditors and help ensure that beneficiaries don’t spend down their inheritances too quickly. However, trusts are now subject to the same 10-year liquidation requirements, so the new rules may conflict with the original reasons the trusts were established.
IRA owners and retirement plan participants should review their beneficiary designations with their tax professional and consider how the new rules may affect inheritances and taxes. Any strategies that include trusts as beneficiaries should be considered very carefully.

Please contact Partner Richard Petrucci at 401-831-0200 if you would like to discuss how these new rules apply to your IRA or retirement plan. You may want to revisit your estate plan and consider alternative planning opportunities.

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