Planning Around 10-Year Withdrawal Requirements from Inherited IRAs by Jeffrey M. Mutnik, CPA/PFS
Posted on November 09, 2023
Certain non-spouse beneficiaries of inherited IRAs will need to begin taking annual RMDs from those accounts beginning in 2024 to satisfy the SECURE Act’s 10-year rule, which requires the liquidation of those accounts within 10 years of the original owner’s death. While the law eliminating stretch IRAs was passed in 2019, the IRS has since delayed the start date three times. Consequently, affected beneficiaries could find themselves saddled with higher-than-expected withdrawal requirements that could leave them with higher tax liabilities and the risk of falling into a higher tax bracket.
Ongoing estate planning can help individuals and their beneficiaries adapt to changing tax laws, enabling them to achieve their wealth accumulation and preservation goals while minimizing their exposure to higher tax liabilities. The 10-year IRA withdrawal rule is no different. Following are some strategies you may consider under the guidance of your trusted CPAs and financial advisors to determine which one may work best for you and your family’s unique circumstances.
Roth IRA Conversions
With tax rates currently at historically low levels, now may be a good time to consider converting a traditional IRA to a Roth IRA and immediately paying tax on the transferred amount. In doing so, you and your named beneficiaries can enjoy the benefit of tax-free withdrawals in the future, since withdrawals taken from Roths are not subject to tax as long as you are age 59½ or older and have owned the account for a minimum of five years.
While the immediate tax liability of a Roth conversion may be substantial, it is likely to be less than the amount of tax you or your heirs will pay in the future on annual required minimum distributions (RMDs) from traditional IRAs at potentially higher tax rates. There are no RMDs with Roth IRAs. However, it is important to remember that the tax liabilities you incur taking RMDs from a traditional IRA during your lifetime may also help to reduce the size of your taxable estate and your family’s exposure to estate taxes in the future. This can be a valuable benefit as the government reduces the estate tax exemption, and more families become subject to estate tax.
Year-end tax planning should include a discussion of your marginal tax rate to determine if a distribution in this calendar year would be taxed at an acceptable level for you.
Divide IRA Assets Strategically Among Several Beneficiaries
Rather than leaving all your IRA assets to one or two beneficiaries and exposing them to the risks of the 10-year withdrawal rules (and a potentially higher tax bracket), consider divvying up your savings among a larger group of beneficiaries. This will enable you to share your wealth and leave behind the legacy you intended without exposing your heirs to substantial tax bills.
Donate IRA Assets to Charity
Naming a charity as the beneficiary of your IRA or creating a charitable remainder trust (CRT) or charitable lead trust (CLT) to receive your accumulating retirement savings after your passing generally escapes the stretch IRA limitations and related tax liabilities on your heirs. In fact, with a CRT, you can name your heirs as beneficiaries to receive distributions from the trust. Moreover, you do not need to wait until your death to be charitable with an IRA. Under U.S. tax laws, you may donate your annual RMDs up to $100,000 annually to a qualified charity after you reach age 72, thereby reducing the size of your taxable estate and the tax liabilities passed to beneficiaries who inherit your IRA account. Note that each spouse can use this benefit, allowing up to $200,000 to go directly to charity without having to report the distribution as income.
Buy a Cash-Value Life Insurance Policy
A cash-value life insurance policy funded with IRA withdrawals will reduce the taxable value of your IRA account while enabling you to continue saving for retirement and providing your heirs with a tax-free, lump-sum death benefit at the time of your passing. Your ability to fund a cash-value policy with your IRA assets depends on your age and the value of your estate.
It is important to remember that passing an IRA of substantial size to non-spouse beneficiaries under the SECURE Act’s 10-year distribution rule can not only have a significant impact on their tax liabilities, but it can also affect beneficiaries’ unique financial planning needs and longer-term retirement savings goals. Ongoing estate planning is the best way to ensure you leave your heirs with a lasting legacy that also maximizes tax efficiency.
About the Author: Jeffrey M. Mutnik, CPA/PFS, is a director of Taxation and Financial Services with Berkowitz Pollack Brant Advisors + CPAs, where he provides tax- and estate-planning counsel to high-net-worth families, closely held businesses and professional services firms. He can be reached at the CPA firm’s Ft. Lauderdale, Fla., office at (954) 712-7000 or via email at email@example.com.