Recent changes to Individual Retirement Account (IRA) provisions will keep estate planning attorneys busy in the new year.

No more age restriction on traditional IRA contributions

Many proponents of the recently signed SECURE Act are touting the repeal of the age restriction on traditional IRAs allowing investors to continue contributing to their accounts after they have turned 70 ½ and the postponement of required minimum distributions (RMDs) from 70 ½ to 72. However, the bill has negative effects as well.

Prior to the Setting Every Community Up for Retirement Enhancement (SECURE) Act, which President Trump signed into law on Dec. 20, 2019, IRA owners could use their accounts to pass along a particularly tax-advantaged inheritance to their descendants.

No more stretch IRAs

However, the new law severely limits what had been known as “stretch” IRAs. In addition, the act could have adverse tax implications for beneficiaries.

The SECURE Act requires most non-spouse beneficiaries to drain their inherited IRA accounts within 10 years of the account owner’s death, often incurring taxes on those withdrawals. Exceptions apply to minor children, beneficiaries less than 10 years younger than the account owner and chronically ill beneficiaries. The change applies to IRAs inherited after Jan. 1, 2020.

Previously, annual RMDs were determined by the IRS-defined life expectancy of the beneficiary. For example, a 40-year-old, non-spouse beneficiary of a Roth IRA might enjoy the federal-income-tax-free inheritance benefits for 43.6 years. Now, unless one of the exceptions applies, beneficiaries are limited to 10 years of benefits. The 10-year rule applies to minor children once they reach the age of majority.

A Reason to Review Trusts

Depending on the type of IRA inherited, these changes could trigger a major tax event for some beneficiaries. Roth IRAs are funded with post-tax dollars so distributions are tax free. However, traditional IRAs are funded with pre-tax funds so those dollars are taxable upon distribution. Previously, this was not a big concern because the money could be withdrawn a little at a time. However, with the shorter withdrawal time frame traditional IRA beneficiaries may see significant tax hikes. This is especially true if the IRA was tied to a trust.

Some IRA owners set up “conduit” or “pass-through” trusts as beneficiaries of their accounts to help manage the inherited accounts and provide protections from creditors. Some of these trusts were designed to only make distributions to beneficiaries based on the “RMD due each year.” The SECURE Act only requires an RMD at the end of 10 years. Therefore, a beneficiary could receive nothing for 10 years and then the entire account all at once. If the account is a traditional IRA, that could have serious tax implications.

After these significant changes, IRA owners may want to consult with a trusted estate planning attorney about the implications of changing their beneficiaries, converting traditional IRAs to Roth IRAs or changing the terms of their trusts. They may also want to consult an estate planning attorney about other options to provide an inheritance for an heir if their intended beneficiary is no longer eligible for “stretch treatment” based on these new regulations.