Are you about to make your annual IRA contribution so you can get the income tax deduction before you file your return? It might still be a good idea, but it isn’t as good as it used to be. As part of Congress’ December 2019 budget deal, the so-called SECURE Act made three major changes affecting retirement plans.
First let’s cover the good news. No matter how old you are, if you have earned income you can still make tax deductible contributions to a qualified retirement account (IRA). For the farmers, for instance, who keep working into their 70s and want to put money in an IRA, this is an opportunity.
Second, also good news, is that the Required Beginning Date for taxable IRAs is now April 1st of the year following your 72nd birthday. In other words, that is when you must start withdrawing and paying income taxes on a small amount from your IRA. Under the prior law, you had to start making these taxable withdrawals during the year in which you reached age 70.5. So, if you don’t need the money to live on and want to leave it in the IRA you can defer income tax for a couple more years.
The third change is ugly and will affect your beneficiaries. It is the new “Ten-Year Rule” for taxation of your IRA after death. Until this year, after your death your IRA beneficiary could let most of the money continue to grow tax-deferred, withdrawing only a small amount each year. The annual, taxable withdrawal was calculated so that it could be spread out over their entire life. For instance, as explained here
, a 51 year old beneficiary could stretch their withdrawals over 34 years. If your daughter inherited a $200,000 IRA under the former rules and kept it invested at 5% per year, after ten years of withdrawals she will have withdrawn over $144,000 from the account, starting at about $6,000 per year and gradually increasing during that time to about $12,000. But she would still have over $241,000 in the account withdraw from for additional 24 more years.
Under the new SECURE Act, your beneficiary will have to withdraw and pay income taxes on the whole account within ten years of your death. Consider your 51 year old daughter with that same $200,000 IRA. Now she can let it grow until the 10th year, but will then have to withdraw it all—$325,779—and report it all as income that year. Or, she could withdraw and pay income taxes on about $26,000 annually for ten years.
This new Ten-Year Rule takes the wind out of the sails of what we used to call a “stretch-out IRA.”
There are four categories of beneficiaries who don’t have to withdraw all the IRA within 10 years. If you leave your IRA to
your surviving spouse, he or she can claim the IRA as if it was their own. This means they won’t have to withdraw anything until age 72, and then only a small amount each year for life (when they die and pass the IRA to other beneficiaries, however, the Ten-Year Rule will apply);
your own a minor child, the mandatory withdrawals are very small (less than 2% per year) until the child reaches age 18 (then the Ten-Year Rule kicks in and the rest of the IRA must be withdrawn and all taxes paid by age 28);
an individual not more than 10 years younger than you, he or she can withdraw the IRA funds under the old “stretch-out” rule (but who would you choose, since presumably most of your intended heirs are more than 10 years younger than you?). This category will primarily fit those without children who might leave their IRA to siblings;
a chronically ill individual or a disabled individual, the old “stretch-out” rules generally still apply.
One last issue that is especially important in estate planning. If an IRA under the Ten-Year Rule is paid out on your death to a typical trust, the Ten-Year Rule can now cause outrageous income taxes. If your heirs are going to have the benefit of asset protection trusts
for their inheritance, including the IRA, make sure that those trusts include the very latest income-tax-reduction provisions.
With the right sort of asset protection trust, the IRA could be distributed over ten years to the trust and spent if needed, but if the beneficiary doesn’t need the money it can be reinvested within the protection of the trust and without the high income taxes often associated with trusts. There the unspent funds will remain safe from divorce, lawsuits and the beneficiary’s other life risks. But to get this result it is critical that the trust be up-to-date. Trust are not all the same!
The first version of this article appeared in The Prairie Farmer® online January, 2020
, and print edition March, 2020