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How Does My Inherited IRA Fit into Estate Planning?

The Secure Act (Setting Every Community Up for Retirement Enhancement Act) was signed into law on Dec. 20, 2019 and includes many reforms that could make saving for retirement easier and more accessible for many Americans, says CNBC’s recent article entitled “Did you know inherited qualified retirement accounts must be liquidated in 10 years? If you didn’t, you are not alone.” However, the Secure Act made a major change for beneficiaries of individual retirement accounts and 401(k) plans.

The Act requires that inherited qualified retirement accounts must be liquidated within 10 years. Therefore, if you inherit an IRA or a 401(k) plan from someone other than your spouse, it could affect your retirement savings plans or strategies to transfer wealth to future generations.

Before this, if you inherited an IRA or 401(k), you could “stretch” your taxable distributions and tax payments out over your life expectancy. However, for IRAs inherited from original owners that passed away on or after January 1, 2020, the new law now requires most beneficiaries to withdraw assets from an inherited IRA or 401(k) plan within 10 years following the death of the account holder.

Retirees whose taxable income is less than their heirs’ – which is the case for most retirees – should at least consider whether it makes sense to take a different approach if they were to draw down their qualified assets more aggressively and keep larger non-qualified account balances, their tax obligation could be far less than what their higher-earning heirs may pay in the future.

They also could make strategic withdrawals from non-qualified accounts to ensure that their rate doesn’t go up significantly. That means reaching the limits of one bracket without going into the next one.

Moreover, because their non-qualified accounts receive a step-up in basis, this would reduce their heirs’ tax burden even further. That is because the gains on these accounts are taxed based on the value when the benefactor dies.

However, it’s true that not everyone will embrace a new plan like this. You may feel like you’ve saved and invested for decades and, therefore, shouldn’t have to worry about whether your adult child must pay a bit more in taxes each year.

However, to reiterate, we’re not talking about pennies on the dollar. The stakes for some could be well over $100,000. Just as many put in place estate-planning strategies to protect more of their wealth, it’s at least worth sitting down with an estate planning attorney to consider whether it makes sense to do the same when it comes to the implications of the Secure Act.

Reference: CNBC (Feb. 8, 2022) “Did you know inherited qualified retirement accounts must be liquidated in 10 years? If you didn’t, you are not alone”

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