IRA Beneficiary Designations

As you may know, the Secure Act put an end to the Stretch IRA. The stretch IRA is the ability to stretch the IRA distributions over the beneficiaries’ lifetime. Let us look at the new rules to see how this may impact your current situation.

When the owner of an IRA (or another retirement plan) dies, the account goes to the beneficiaries designated on the account. The beneficiary then must take Required Minimum Distributions from this new Inherited IRA account. Before the Secure Act, beneficiaries were allowed to take Required Minimum Distributions over their own life expectancy. With the Secure Act in place, there are not Required Minimum Distributions for the beneficiary any longer, however, the account must be distributed to the beneficiary by the 10thyear after date of death. There are a few exceptions to the 10-year rule:

  • Surviving spouse
  • Minor child-subject to 10-yearrule once they reach age of majority
  • Disabled or chronically ill person
  • Person not more than 10 years younger than the account owner

If the beneficiary is not an individual (such as the owner’s estate), then the account must be distributed within 5 years after the date of death.

Why is this important? If there is a significant amount of money in a tax deferred IRA, then the beneficiary’s inheritance can be eaten away with taxes. For example, a 30-year-old inherits an IRA from a parent worth $1M. This beneficiary has 10 years to take the money out of the IRA—they are not required to take the money out each year, it just must be done within 10 years.

Examples of how this might play out:

30-year-old beneficiary earns $50K per year and has no state income tax

Example 1-Beneficiary takes out $100K per year until account is empty at year 10 (assuming no growth for ease of calculations and tax rates remain the same)

Beneficiary is in the 12% income tax bracket. The $100K will fill up the remaining portion of the 12% bracket, then be taxed at the 22% and 24% brackets, leaving the net amount of the $100K to be $77,286.

Result is that $227,140 is paid in taxes, netting $772,860 in after tax inheritance over 10 years.

Example 2-the only change from Example 1 is that the beneficiary takes out the full $1M at once

Result is that $343,633 is paid in taxes, netting $656,367 in after tax inheritance if taken out at once.

The above examples are overly simplistic and is not how situations would pan out in real life, but it does illustrate how the distribution of a tax deferred account over the 10-year period can save significant tax money.

Every situation is different, and all financial decisions should be tailored to your situation.

Financial Journey LLC is a registered investment advisor offering advisory services in the state of Virginia and in other jurisdictions where exempted. Information provided is for educational purposes only and not, in any way, to be considered investment or tax advice.

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