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Retirement Planning > Saving for Retirement > IRAs

The Secure Act Changed Inherited IRA Rules. What's an Advisor to Do?

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What You Need to Know

  • The Secure Act has made inherited IRAs less attractive for most non-spousal beneficiaries.
  • Roth IRAs can be a versatile tool in both retirement planning and estate planning for clients.
  • To pass a stock portfolio to heirs, a taxable account could be a better choice than a traditional IRA.

The Setting Every Community Up for Retirement Enhancement (Secure) Act upended inherited IRAs for most non-spousal beneficiaries. The 10-year rule for withdrawing from inherited IRAs eliminated the ability to stretch inherited IRAs for these beneficiaries.

The IRS recently released proposed regulations on this rule, under which IRA beneficiaries must take required minimum distributions in years one through nine if the account owner died after their required beginning date. According to expert Ed Slott, these rules are already effective.

Even without this seemingly new twist on the 10-year rule, the Secure Act has made inheriting an IRA less attractive for most non-spousal beneficiaries due to the bigger tax hit many beneficiaries will experience. 

Look at the Whole Picture 

IRAs are often one of the largest stores of wealth for many of your clients. As such, they are often a major part of their estate planning through the beneficiary designations on the account. 

A key starting point is to look at your client’s overall situation as it pertains to both their retirement and their estate planning goals. The first concern with IRAs should be ensuring that your clients have sufficient assets to cover their retirement needs and the role that their IRAs play in satisfying these income needs for retirement.

Once their retirement needs are covered, take a look at your client’s estate planning goals. If they are married, spouses will generally be the primary beneficiaries of each other’s IRAs and other assets. Another important factor to consider is taxes, both your client’s tax situation and those of their non-spousal beneficiaries. 

Roth IRAs

Roth IRAs provide a versatile solution on several fronts. 

First, money in a Roth IRA is not subject to RMDs and can be withdrawn in retirement as and if needed by your client tax-free. Money in a Roth 401(k) can be rolled over to a Roth IRA and receive the same tax treatment. In all cases it’s important to ensure the five-year rule is satisfied first. 

As far as inherited IRAs go, Roth IRAs can be passed to beneficiaries income tax-free as well. Non-spousal beneficiaries can take withdrawals from inherited Roth IRAs tax-free as long as the account holder had met the five-year rule prior to their death. The beneficiaries can then use this money as they see fit without having a chunk of the value eroded from the higher taxes that can result from the compressed 10-year withdrawal period. 

It’s important to note that Roth IRAs are not exempt from federal estate taxes (traditional IRAs aren’t, either). By making Roth conversions, your client can prepay income taxes for heirs while reducing the size of their taxable estate. You will, however, want to work with your client to look at the relative tax implications of their paying the taxes now versus letting their beneficiaries deal with the taxes in the future. 

Roth IRA conversions can be done over time, and you can work with clients to determine if their income will be lower than normal in a particular year, offering a good opportunity to do a conversion from a tax perspective. 

This is a versatile strategy in that your client can convert any portion of their traditional IRAs that they choose. They can use the converted IRAs for their own purposes in retirement or earmark these assets for the next generation. 

Look at Your Client’s Withdrawal Strategy

A key point to consider is how IRAs factor into your client’s retirement withdrawal strategy. Are they one of the larger components of their overall retirement assets? In this case, the focus should be on managing distributions from the IRA rather than how they will fit into your client’s estate planning.

Their retirement withdrawal strategy will vary at different points in their retirement. Tapping traditional IRAs might make sense during their early years of retirement, in the “gap” period prior to their claiming Social Security benefits. This is a period when many clients will find themselves in a lower tax bracket, and drawing from traditional IRAs early can reduce the sting of future RMDs. 

How Do IRAs Fit Into Your Client’s Estate Planning?

Every client is different in terms of the composition of their assets and their desires for estate planning. With the new rules for inherited IRAs under the Secure Act, leaving traditional IRAs to most non-spousal beneficiaries is not as desirable as it was before this change in the rules. 

If your client has significant assets outside of their retirement accounts, focus on how those assets are treated for estate planning purposes. The size of your client’s estate must be considered as well. 

For example, if the client has a stock portfolio held in taxable accounts, this might be a better asset to pass on to heirs than traditional IRAs. The step-up in basis rules can reduce or eliminate the impact of embedded capital gains on their heirs. 

Assets such as real estate, art and collectibles, or an interest in a business are all viable assets to pass on to the client’s heirs.

Working With the Beneficiaries 

It’s always been a good idea for advisors to engage in a family meeting involving their clients and adult children or other adult family members who will benefit from the client’s estate. This can help you understand the family dynamics and the financial situation of the beneficiaries.

This can be a good time to ensure that everyone understands the new inherited IRA rules and why it might make sense to have the client spend down their traditional IRA and/or do a Roth conversion. This is a good time to provide the next generation with thoughts on how they will need to handle an inherited IRA or deal with other inherited assets. 

After the death of a client, the beneficiaries may seek your advice on how they should deal with an inherited IRA or other assets. If you’ve gotten to know them and their situation a bit already, you will be in a better position to advise them and perhaps build a client relationship with them. 

In other cases where a client has inherited an IRA from a parent or other relative, it’s important to fully understand the new inherited IRA rules and how they affect your client. One scenario might be to have them take a bigger portion of an inherited traditional IRA in years where their income might be lower than normal. 

The Secure Act changed the landscape of inherited IRAs as a wealth transfer vehicle. Your clients look to you for the best advice on managing their retirement finances and their estate planning. Be sure you are up to speed on these new rules and how they might factor in your clients’ use of IRAs as an estate planning tool.

 Roger Wohlner is a financial writer with over 20 years of industry experience as a financial advisor.


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