Archives For Setting Every Community Up for Retirement Enhancement

Quiz!

What is a way to minimize taxes under the new SECURE Act that limits inherited IRA distributions to 10 years?

  1. Distribute the inherited balance in equal amounts over 10 years.
  2. Each year, distribute the remaining balance divided by the remaining years.
  3. Convert the IRA to a Roth IRA during your lifetime, while your heirs distribute the entire Roth IRA on the end of the 10th year.
  4. Distribute larger amounts early on, to account for the growing balance with investment growth.

Optimizing the Stretch IRA under the new SECURE Act

On December 20 we got a new law: the SECURE Act (Setting Every Community Up for Retirement Enhancement). One of its provisions eliminated the distributions of inherited IRAs over the heir’s lifetime (often referred to as Stretch IRA) for most people. Instead, these IRAs typically have to be distributed within 10 years. The distribution can happen at any point in the 10 years. Spreading the distributions evenly can minimize income taxes for your heirs, but in some cases there is a strategy that can significantly improve this solution:

  1. Convert the IRA to a Roth IRA during your lifetime at a schedule that is designed to minimize your income taxes. See ideas in my article: Planning for Unlimited Roth IRA Conversions.
  2. Your heirs distribute the entire Roth IRA near the end of the 10th year of inheriting it.

This can maximize the IRA benefit, by paying no dividend and capital gains taxes on the investments for your lifespan + a full 10 additional years for your heirs.

Important Considerations:

  1. This works as long as the account is left untouched (or mostly untouched) until 10 years after the inheritance. Otherwise, a more careful analysis is needed.
  2. There is no way to access Traditional IRA money without paying income tax on it, so it is worth analyzing carefully weather a Roth Conversion is beneficial in your lifetime, regardless of planning for your heirs.
  3. When thinking about your heirs, note that the new rule adds at least 10% of your future IRA balance to their income (in case of even withdrawals over the maximum 10 years). So, even if they are in a low income tax bracket, a large enough IRA can push them to one of the top income tax brackets, making a Roth Conversion in your lifetime beneficial to them.
  4. If the beneficiary of your IRA is your Trust, and the trust limits IRA distributions to the minimum required distributions, the new law will lead your heirs to not see a dime from your IRA until 10 years after inheriting it, and then getting a potentially huge tax bill at high tax rates all at once. If this is not in line with your wishes, it is worth reviewing your trust document.

Quiz Answer:

What is a way to minimize taxes under the new SECURE Act that limits inherited IRA distributions to 10 years?

  1. Distribute the inherited balance in equal amounts over 10 years.
  2. Each year, distribute the remaining balance divided by the remaining years.
  3. Convert the IRA to a Roth IRA during your lifetime, while your heirs distribute the entire Roth IRA on the end of the 10th year. [Correct Answer]
  4. Distribute larger amounts early on, to account for the growing balance with investment growth.

Explanation: In cases where a Roth Conversion during your lifetime could make sense, this plan allows your heirs to enjoy a full 10 years of tax-free investing (dividend & capital gains tax) with your IRA, while you enjoy paying income taxes on IRAs at the optimal time. This works if you and your heirs don’t need most of your IRA until 10 years after they inherit it.

Disclosures Including Backtested Performance Data