New SECURE Act takes Aim at Large IRAs and 401(k)s
Updated: Apr 7, 2022
IRA’s or 401(k)’s with over $500k in assets may cause tax headaches for beneficiaries who inherit them because of the new SECURE Act law. You can take action now to minimize your beneficiaries’ taxes.
What the SECURE Act changed: One of its most significant provisions of the Act was the elimination of what was called the “Stretch” IRA, which used to allow children (or other non-spouse beneficiaries of IRAs) to stretch out the withdrawals from these accounts over their expected lifetimes, usually 30 years or more. The new SECURE Act requires that all the money in these accounts must be taken out (and taxed!) within 10 years of the death of the original account owner.
Since all this money is taxable as regular income, usually the beneficiary will want to spread the money out over multiple years to avoid moving up to a higher tax bracket AND to allow the money to continue to grow tax-free.
Why is this an issue for large IRAs or 401(k)’s?: Since the money in the inherited IRA can now only be spread over 10 years (best case), an IRA with $500k in it will add at least $50,000 (=$500k/10) of taxable income on-top of the beneficiary’s other income, which will often significantly increase their taxes by pushing them into a higher tax bracket. If the beneficiary takes all the money out at once, then they will likely be paying the maximum tax rate, which is currently 37%. Plus…. inherited IRA distributions are considered “unearned income” by the IRS, and face an added 3.8% Medicare tax for high income taxpayers.
What can I do if I have a large IRA or 401(k)?: Inter-generational tax planning has become more important.
Maybe you should pay the taxes instead of your children: If you are able to manage your money to keep yourself in a low tax bracket in retirement, it may make sense to withdraw “extra” money from your IRA so that it is taxed at your rate, not that of your working children. If you invest this “extra” money, the children usually won’t have to pay taxes on it when they inherit it. Spread your IRA money over more beneficiaries: If you were considering giving money directly to your adult grandchildren, this would spread out the taxable IRA money over more tax payers, which would lower the likelihood of bumping up into higher brackets. If you are charitably inclined: IRA money given to a charity is not taxed, so it is now even more beneficial to give to charities out of your IRA, not your other accounts. There is even a thing called a Charitable Remainder Unit Trust (CRUT) that can be used to reduce the taxes on the IRA while still giving an income stream to your beneficiaries. Other Useful Details:
The SECURE Act went into effect on January 1, 2020, so it applies to anyone who died after that date. The SECURE Act applies to all similar types of tax-deferred retirement accounts, like 403(b)’s, 457(b)’s, ESOP’s, and other plans. There are some exceptions, like for disabled beneficiaries and minor children, so if you have a special case, consult an expert like a financial planner or a CPA. Bottom Line: If you have a large IRA or 401(k) account, it makes sense to do some inter-generational tax planning because of the new SECURE Act.