The SECURE Act just blew up the rules around stretch IRAs, otherwise known as inherited IRAs. Absolutely insane!
The SECURE Act is a massive piece of legislation that has provisions in it that cover everything from paying off your student loans using 529 funds to what I’m talking about today, which is the most impactful in my opinion. It’s the provision that will bring in $15.7 billion in revenue to the treasury over the next 10 years.
In Today’s video, I’m talking about:
- How the rules around Stretch IRAs have changed
- Challenges you might face with the new IRA rules
- Tax planning strategies that could help you and your beneficiaries save big on taxes!
Click here to watch the full video or read the full video transcript, below.
Old Rule Vs. New Rule
Let’s take a step back and talk about the old rule with stretch or inherited IRAs and the new rule under the SECURE Act. Prior to 2020, if you inherited an IRA from your parents, in most cases you would have been able to take money out every year, over the remainder of your life.
If you had inherited this money when you were 55 and you lived to be 85, that’s 30 years that you could have spread out the distributions. More importantly, you could spread out the taxes because every dollar that you pulled out of an IRA account was subject to tax.
Under the new rule, instead of taking money out over 30 years, you now have a cap of 10 years to take that money out as a beneficiary. There are some exceptions to this rule. However, most people set up their IRAs so that when they die and their spouse dies, the money goes to their children. If that’s the case for you, then this is almost certainly going to apply in your situation.
Problem With The New Inherited IRA Rule
Let’s say that when you die, you have $1 million in your IRA. That gets split between both of your kids with half a million dollars going to each child. Now their income is going to jump by $50,000 every year for the next 10 years, if they do the full stretch IRA.
A lot of times, people inherit money in their 50s and 60s, often during their peak earning years. This is typically when your income is already as high as it’s going to be in your working career. Now you’re adding on sizable retirement required distributions from mom or dad’s IRA on top of that.
The problem is, this can potentially wreak havoc and throw you into a higher tax bracket. That money that your parents worked for, or you if you’re the account holder, potentially half of it could go to taxes.
What does this have to do with the Roth? Well, the Roth just got a lot more attractive! When you put money into a Roth, you’re taxed on it that year so you don’t get the taxed on the contributions. From there, it grows tax free. When you pull the money out, whether it’s you or your beneficiaries, that money is not taxed!
Now there’s this unique opportunity now where if you weren’t already contributing to a Roth, you may want to look closely at that because the more money you can get into the Roth and out of the traditional IRA, the better. And there’s a couple of ways you can do that.
- Roth Conversion Strategy
One is through conversions. You can take money that you already have in an existing IRA or 401k account and you can pay the taxes now and convert that to a Roth. Historically taxes have been fairly low recently so it’s a good time to look at doing that anyway, even if the SECURE Act hadn’t recently passed.
- Roth Contribution Strategy
The other strategy that I think makes a lot more sense because you’re not paying taxes on those conversions, is looking seriously at Roth 401k or Roth IRA contributions. I specifically want to emphasize the Roth 401k contributions because if you have access to a 401k plan through your work, there’s a decent chance that there’s a Roth option attached to that. And if you are over 50, you can put a substantial amount of money into a Roth 401k every year. It’s $25,000 for 2020.
If you’re going to work say 15 more years, that’s a substantial amount of money that can be contributed and grow and not be taxed on later that is now inside of your Roth. So really big planning opportunity that now exists with the Roth.
Other Planning Strategies
There are some additional planning strategies beyond the Roth that you may want to consider, ways that you can minimize taxes:
- Evaluate how your trusts are set up
- Shuffle your beneficiaries around
- Switch how you take distributions from your account
- (Counter to traditional advice) You could preserve more of your taxable account, which is likely to be taxed at a lower rate when it gets inherited by your beneficiaries, and then deplete more of the IRA account
These aren’t blanket recommendations because it depends on the account types that you have, the account sizes, your income, etc. You really need to talk to your tax advisor and your estate planning attorney to see if the new change of the law with the stretch or the inherited IRA is going to have an impact on you.
There are planning strategies that you can undertake in order to make sure that you are being as efficient as possible with those hard-earned dollars and not handing half of them over to uncle Sam when your heirs start taking those distributions.