Estate planning strategies that can reduce the tax burden are always welcome news for Illinois residents who want to take care of loved ones after they are gone. With ever-changing tax laws, however, it can be challenging to keep up with the new rules and how these may affect your planned giving.
Although tax laws in 2017 eased some rules to allow more assets to pass on to heirs tax-free, some legislation that has followed targets how beneficiaries can access their inherited IRAs. Legacy planners in Godfrey and surrounding communities may want to take advantage of experienced estate planning services when reviewing their options.
How the stretch IRA has changed
It was once possible for individuals to leave an IRA such as a 403(b) or 401(k) as a gift that non-spouse beneficiaries, often the children of the deceased, could access over the course of a lifetime. The beneficiary had the option of withdrawing funds from the IRA by following the Internal Revenue Service (IRS) uniform lifetime table. These guidelines would base withdrawal amounts on the current age of the beneficiary and their life expectancy to calculate the required minimum distributions (RMDs).
As a result of tax legislation in 2019, the benefits of the “stretch IRA” are no longer an option if the decedent passed away after January 1, 2020. Now, beneficiaries must deplete an inherited IRA account within a ten-year period. The tax implications of this new rule are significant, as a yearly distribution spread out over ten years could trigger a tax rate of 12% to 22%, or higher.
The new rules do not apply to non-spouse beneficiaries whose relative passed away before 2019. They also do not apply to:
- Minor beneficiaries. The ten-year payout begins when they reach the age of maturity.
- Disabled beneficiaries.
- Beneficiaries who are less than ten years younger than the decedent.
Spouses may still take RMDs, but they should fulfill any RMD that the deceased owed in the IRA to avoid a 50% penalty tax on what remains. They could also choose to remain a beneficiary on the account, which will delay RMD withdrawal requirements.
Considering other options
An awareness of these changes may prompt estate planners to consider different avenues for giving. Some options for channeling assets to loved ones may include:
- A Roth conversion which will become an inherited Roth IRA, with tax-free distributions if left untouched for five years. Beneficiaries cannot convert an IRA into a Roth IRA.
- A revocable trust.
- A charitable remainder trust.
It may be wise to also examine the existing trust payout terms to avoid taxes on a lump sum payout after ten years.