I.R.A. Rules Have Changed, and Heirs Need to Pay Attention

If you’re fortunate enough to own or inherit an I.R.A., there are some new rules you’ll want to know about.

They are part of the Secure Act — short for the Setting Every Community Up for Retirement Enhancement Act, which Congress passed last year. The law made dozens of changes in rules for retirement plans, including tweaks aimed at helping people save more of a nest egg.

The law, for instance, did away with the deadline for contributing to an individual retirement account. Previously, savers had to stop stashing money away when they turned 70½ — and they had to start taking money out each year.

But now, you can save in an I.R.A. past the old cutoff, as long as you’re working. And you don’t have to start taking money out until you turn 72. The change recognizes that people are living and working longer and need more time to save.

Other parts of the law, however, put restrictions on inherited I.R.A.s, and if you have one or are thinking of bequeathing one, it’s worth paying attention.

Before this year, those lucky enough to inherit an individual retirement account had to take some money out of it each year. However, they could “stretch” out the withdrawals over their lifetimes — years or even decades, depending on their age when they came into the money. They were able to withdraw small amounts annually, to soften the impact on their income taxes, while keeping the balance invested.

“You could take little crumbs out, and let it grow tax-deferred over decades,” said Ed Slott, a certified public accountant and I.R.A. expert in Rockville Centre, N.Y. Required annual withdrawals were based on life expectancy, so the technique was especially helpful for young children or grandchildren, whose mandatory withdrawals would be quite small.

Under the new rules, many people who inherit an I.R.A. must now empty it, and pay any required taxes, within 10 years. That means some people could end up having to pay more in income taxes, and will have less time for the money to remain invested and grow. Someone who inherits an I.R.A. from a parent at age 55, for example, might be at her peak earning period, and would prefer to delay adding to her income to avoid higher taxes. Now, though, she must drain the funds within a decade, said David Flores Wilson, a certified financial planner in New York City.

The new rules apply to accounts inherited after Dec. 31, 2019. Heirs of I.R.A. owners who died in 2019 and earlier can still use the stretch approach.

The stretch technique isn’t entirely obsolete, even for newly inherited I.R.A.s. A spouse may still inherit an I.R.A. and continue to stretch withdrawals over time, and so can the account owner’s children — at least, until they turn 18 or 21 (the 10-year clock starts then), depending on the state.

People with disabilities and those with chronic illnesses who inherit an I.R.A. also are exempt from the 10-year withdrawal deadline. And a beneficiary who is less than 10 years younger than the account’s owner — say, a brother or sister — can also continue to “stretch” the I.R.A.

The new rules apply to both traditional I.R.A.s and Roth I.R.A.s (in which contributions are made after tax and grow tax-free) as well as 401(k) workplace retirement accounts.

The rules don’t take effect until 2022, though, for 403(b) and 457(b) plans, available to government and nonprofit workers, as well as for the federal Thrift Savings Plan, the retirement program for federal employees. So someone inheriting one of those accounts in the next two years can still use the stretch option.

On the plus side, the new rules for inherited I.R.A.s did away with one onerous feature: required minimum withdrawals. Instead of being obligated to withdraw some money each year, those who inherit an account can take withdrawals periodically or wait until the end of the 10-year period to drain the balance, if that works best for them, Mr. Slott said.

Anyone could benefit from the ability to stretch out I.R.A. distributions, but the technique was especially popular as an estate-planning tool for affluent people.

“The stretch was a tremendous wealth-building strategy between generations,” Mr. Wilson said.

People who want to leave an I.R.A. to heirs, but avoid burdening them with a potential tax bill still have some options.

They could convert their retirement account to a Roth I.R.A., said Nick Holeman, a certified financial planner with the online adviser Betterment. Unlike with traditional I.R.A.s, money is contributed to a Roth after-tax, so taxes generally aren’t owed on withdrawals as long as certain rules are followed. The account owner would owe taxes at the time of the conversion, but withdrawals would then be tax-free to the heirs.

“The Roth option as a planning tool becomes more interesting” under the new rules, said Ephie Coumanakos, a wealth manager in Wilmington, Del.

Another approach is for the account owner to divide the I.R.A. funds among several beneficiaries, giving each less money, and minimizing certain tax concerns.

The new rules contain potential minefields, especially for people who have chosen a trust as the beneficiary of an I.R.A., on behalf of children or grandchildren. Trusts are tools used to direct how funds are distributed, and to protect funds from mismanagement, or from loss in cases of divorce or liability.

Certain kinds of trusts can qualify for stretch I.R.A.s. One example is a “conduit” trust, which immediately funnels required withdrawals from an I.R.A. to the trust’s beneficiary. The beneficiaries pay taxes on the money at their personal tax rates. But under the new rule, the trust will have to pay out all of the money within 10 years — a problem for people worried about heirs squandering a big payout.

Instead, it might be worth considering an “accumulation” or discretionary trust, which allows required I.R.A. withdrawals to remain and grow in the trust. In this case, a trustee can dole out funds beyond the 10-year span, said Michael Clear, a lawyer specializing in estate planning at Wiggin and Dana in Greenwich, Conn. There’s a catch, though: Holding onto the money may trigger a larger tax bill, because funds in a trust are typically taxed at a higher rate. Anyone with an I.R.A. with a trust as a beneficiary should consult a professional to see if changes are needed, advisers say.

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