Inherited IRAs, Roth IRAs and Qualified Plans Under the SECURE Act: Estate Planning Considerations
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Inherited IRAs, Roth IRAs and Qualified Plans Under the SECURE Act: Estate Planning Considerations

by Kelly Gillette
September 13, 2021

The SECURE Act erased the life expectancy payout for many designated beneficiaries of inherited IRAs, Roth IRAs and qualified plans, with trust beneficiaries most likely affected in a way contrary to the owner’s original intent. If you designated a trust with your minor children, for example, as the beneficiary of a large IRA or qualified plan with the goal to spread distributions over a long period of time, which allows for income tax planning as well as tax-deferred growth and asset protection, your current plan may not achieve your desired results.

With the new rules in place, it’s time to revisit your estate plan. In this article, we highlight a few key points and provide potential planning opportunities to help you achieve your desired outcomes.

Background

As basic as it seems, regularly confirming your named beneficiaries and making updates as needed is quite often overlooked. Memories fade, and oftentimes someone mistakenly thinks they updated the beneficiary after a marriage, divorce or the death of a primary beneficiary, for example. If the account documents do not reflect your current wishes and a named beneficiary is not who you want your account to go to, it does not matter what your will directs. Beneficiary designations on IRAs, Roth IRAs and qualified plans (to name a few) take precedent and pass to your beneficiaries outside of probate.

Simply stated, a designated beneficiary is an individual or a trust with identifiable individual beneficiaries. Non-designated beneficiaries are anything other than designated beneficiaries, so charities, estates and trusts that have at least one beneficiary that is not an individual fall into this category.

The designated beneficiaries that can still take required minimum distributions (RMDs) over their life expectancy are surviving spouses, eligible minor children (until majority), persons less than 10 years younger, disabled or chronically ill persons or conduit trusts for these designated beneficiaries. These are the eligible designated beneficiaries.

RMD rules did not change for non-designated beneficiaries. So, if prior to the SECURE Act you had a charity, your estate or non-qualifying trust as a beneficiary, the payout is still the 5-year rule.

If tax liability is a primary concern, use spousal rollovers and avoid the 5-year rule by naming eligible designated beneficiaries or qualifying trusts.

What You Need to Know

  • Spouses (eligible designated beneficiaries) have the most options. Naming a spouse as the primary beneficiary offers the most flexibility, allowing them to use their life expectancy for the inherited account rather than the shorter payout periods, or roll it over to their own account where they can also use their life expectancy, defer RMDs until they are 72 and contribute to the account, as well as change beneficiaries.
  • Reviewing and updating beneficiary designations is important. Leaving your IRAs and qualified plans to your estate with no designated beneficiaries leaves very little opportunity for estate or income tax planning for you and your beneficiaries. It is always a great idea to have a contingent beneficiary named as a backup in case a primary beneficiary predeceases you and you forget to update.
  • A charitable remainder trust (CRT) is an option for those who want to support a charity. If you have charitable intent and want to provide your beneficiary a stream of income for a term of years or life, leaving your IRA to a CRT may deliver your desired results. The charity receives the IRA funds and no tax is imposed at that time. The charity then pays out a fixed percentage of the CRT’s asset value each year to the beneficiary. Any potential taxable income to the beneficiary is spread over their life (or term of the trust).
  • Tax bracket planning can provide more to your heirs. Evaluate beneficiaries that have vastly different tax brackets or that live in states that impose an income tax. Directing IRA and qualified plan assets to lower income beneficiaries and Roth IRAs or other assets to higher income beneficiaries can result in an overall greater amount going to your heirs and/or charities rather than the IRS.
  • Increasing the number of beneficiaries could lessen combined tax liability. This is a simple but effective way to spread the distributions among more individuals, thereby potentially lowering the overall tax liability among a family. Depending upon the ages of the beneficiaries, make sure to consider potential effects of the “kiddie tax” on a child’s unearned income in your planning.
  • Consider converting some or all of your qualified plans or IRA accounts to Roth IRAs. This can work very well in certain situations and results in income-tax-free distributions to your beneficiaries.
  • Life insurance is an option. For IRA owners that want the entire value of their account to be available for their heirs, life insurance, if properly structured, can provide liquidity to “replace” the funds used to pay the tax that may be imposed at much higher rates than anticipated if a five- or 10-year payout is required.
  • Separate IRAs with multiple beneficiaries before death. Accounts can be separated after death, but if not done properly and timely, your plan may not end up as anticipated. Separating IRAs now can prevent unintended consequences.

Questions to Ask

  • What is more important for each beneficiary — the ability to stretch distributions over a longer time period or protection of the assets?
  • Does the planning that I have in place consider the laws under the SECURE Act? Can I make additional changes now to avoid mistakes being made later?

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