New federal law impacts ‘stretch’ IRA

A federal law that went into effect on Jan. 1, 2020, is expected to affect inheritance planning for accountholders of retirement plans, such as an IRA.

The Setting Every Community Up for Retirement Enhancement (SECURE) Act, which Congress approved in December 2019, requires non-spouse beneficiaries of inherited IRAs to liquidate the entire account within 10 years of the original accountholder’s death. Previously, the beneficiaries could “stretch” the required minimum distributions and taxes over their lifetime, according to Fidelity.

“There’s this pretty gigantic … law that came out in December 2019 called the SECURE Act,” said Josh Montanez, financial adviser for Northwestern Mutual in Fayetteville. “I think it’d been a lot more talked about if it wasn’t for the fact that COVID followed right after that. It made some pretty big changes.”

According to the law, non-spouse beneficiaries who don’t liquidate the inherited account within 10 years would face a 50% penalty of the balance. They also would be responsible for any taxes owed when the remaining amount is liquidated.

Montanez noted the requirement to liquidate the account in 10 years would not apply to eligible designated beneficiaries, including the original accountholder’s child under the age of 18, a disabled or chronically ill person, or anyone who is not more than 10 years younger than the deceased accountholder.

He explained the strategies to mitigate the tax burden for one’s heirs depend on a person’s finances. But one is to covert the retirement plan into a Roth IRA, which requires taxes to be paid when contributing to it. Heirs who inherit such a plan could withdraw from it tax-free. Another strategy is to structure a life insurance policy to cover the taxes of the retirement plan.

He also highlighted challenges beneficiaries face to liquidate the account in 10 years and that this could affect how they look to receive their income or might push someone into a higher tax bracket.