How the SECURE ACT Has Changed the Rules on Your Retirement Accounts

With the new SECURE ACT that went into effect in December 2020, the rules around your retirement account (Traditional IRA/401K) have been re-written. Here’s one thing you need to know!

Individuals[1] (excluding spouses) who inherit a retirement account from a loved one must now distribute the entire amount within 10 years of the owner’s death!  Your beneficiaries will no longer be able to stretch distributions over their lifetime. It means that they have a few options, the two primarily being to A) take the entire IRA balance out all at once, or B) spread the withdrawals out over the required ten-year timeline.

Option A, taking a lump-sum distribution, could create a significant tax bill for the beneficiary, especially on a large IRA account because all distributions are taxed as ordinary income. If a beneficiary chooses Option B—to spread out the distributions over the required ten-year period—it will also have adverse tax consequences. Assuming the beneficiary is still working and earning an income, those additional distributions are added to his earned income, pushing him into a higher applicable income tax bracket.

Due to this change under the SECURE ACT, you should consider naming your charity as a beneficiary. Why? Charities can receive inherited IRA/401K distributions tax-free (call it Option C).  If you are a donor and have charitable goals, you can take care of your loved one and your charity. By naming your charity as a beneficiary of your Traditional IRA and your family member as a beneficiary of another asset not subject to the negative SECURE ACT distribution rules you create a win-win scenario.

Here is an example:

To keep it simple let’s assume you, as a donor, have two assets. First, a Traditional IRA with a value of $100,000 and, second, a checking account also worth $100,000. Now let’s say you want to leave $100,000 to your local charity and $100,000 to your child. It will not make a difference to the charity where the money comes from; however, where the inherited asset comes from will make a significant difference to your child if they are the named beneficiary of your IRA. Under the SECURE ACT, $100,000 within a Traditional IRA coming to your child will be subject to the ten-year distribution rule. After income taxes are paid on each distribution to your child, he would be left with less money than had he inherited the $100,000-checking account. So, the best solution in this scenario that creates a win-win would be to leave the $100,000-checking account to the child who would receive the full amount without the income tax penalty under the SECURE ACT and designate the $100,000 within the Traditional IRA to your charity which will transfer to them tax-free.

An IRA can be a great thing to have! As the folks at Kiplinger say, “A traditional IRA can be a great way to turbocharge your nest egg by staving off taxes while you’re building your savings. You get a tax break now when you put in deductible contributions.” But with the new SECURE ACT changes to your retirement accounts, it’s important to know your options when planning for the care of your family as well as the charities that are so important to you.  Please keep in mind tax rules continually change and this article is for informational purposes only; always consult with your professional advisors.

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[1] (Excluding spouses, a minor child who is not a grandchild of the original owner, the disabled/chronically ill as defined by the government, or those less than 10 years younger than the original owner. In these limited circumstances the stretch option is possible.)

Disclaimer: This communication does not constitute legal, tax, or financial advice, which we do not provide. Please consult professional advisors concerning the legal, tax, or financial consequences related to your charitable planning.