What the SECURE Act Means for Your Individual Retirement Account (IRA)

What the SECURE Act Means for Your Individual Retirement Account ("IRA")

The SECURE Act, or Setting Every Community Up for Retirement Enhancement Act, took effect on January 1, 2020. The act was designed to make saving for retirement easier and more accessible, but it also changed the way an inherited IRA is paid out to beneficiaries.

The Act changed the age an employee must take Required Minimum Distributions (RMDs) from 70 ½ to 72, allowing workers to save for retirement longer. It also reduced the number of hours part-time employees need to work in order to be eligible to enroll in an employer-sponsored 401K. As a benefit to employers, the Act offers tax incentives to small businesses for starting a retirement plan for their employees.

While the account owner lives, the IRA will be paid out to him or her based on his or her calculated life expectancy. But the SECURE Act changed the way inherited IRA accounts are paid out to beneficiaries after the original account owner’s death. 

Before SECURE, the beneficiary of an inherited IRA was only required to take RMDs over the course of his or her life expectancy. This was commonly referred to as a “stretch IRA.” Now, a beneficiary must empty the IRA within 10 years of the death of the original account holder. Beneficiaries that are excluded from this rule include the surviving spouse, minors, students (up to age 26), and disabled individuals.

This change also affects inherited IRAs that distribute to a trust. As with an outright beneficiary, a trust beneficiary must pay out the entire IRA to the ultimate trust beneficiary within 10 years of the death of the original IRA owner.

Disbursements in excess of the RMD don’t need to be made in equal amounts or disbursed equally over the 10 year period. Rather, the beneficiary has the option of accumulating IRA disbursements in the trust and withdrawing them strategically to reduce overall income tax. This type of trust is referred to as an accumulation trust.

The downside of an accumulation trust is that as the trust grows investment income, that income is taxed at a steep rate. Trust tax brackets are compressed compared to the tax brackets for individuals. Generally, any trust with more than $12,950 of income will have that income taxed at the highest tax bracket- 37%.

The best tax planning for inherited IRA beneficiaries will vary greatly depending on their financial circumstances and expected income and deductions over each year. Reevaluating your estate planning and trust language to allow for flexible distributions is a smart first step to reducing your tax liability from an inherited IRA.