How will tax laws affect legacy planning in retirement?

When Californians plan for retirement, they usually think not just about their own financial comfort and long-term care plan, but also how they can provide for their loved ones after they are gone. Anyone who is involved with estate planning is probably aware of the significant changes to gifting and estate taxation that became law in 2017.

They may not realize, however, that more recent legislation is targeting the manner in which non-spouse beneficiaries can access inherited IRA accounts. The implications of this law may change the way legacy planners view their options in San Jose and elsewhere, as these and other changes may be coming with the current administration.

What was a “stretch IRA”?

Before the new law passed in 2019, non-spouse beneficiaries who were often the children of the deceased had options for withdrawing funds from an IRA like a 403(b) or 401(k), including taking the required minimum distributions over the course of a lifetime. Called a “stretch IRA”, there was an IRS uniform lifetime table that calculated the amount based on the current age and life expectancy of the beneficiary.

Now, under the new rules, beneficiaries no longer have access to IRA funds in this manner if the decedent passed away after January 1, 2020. Under the new law, beneficiaries must deplete the account within ten years. The rule does not apply, however, to:

  • Disabled beneficiaries
  • Beneficiaries who are less than ten years younger than the decedent
  • Minor beneficiaries, for whom the ten-year payout begins when they reach adulthood

These rules do not affect the non-spouse beneficiaries of relatives who passed away before 2019, or to spousal beneficiaries.

Are there other options?

As retirement accounts are often a reliable way to provide for loved ones as part of estate planning, it may be a good idea to review alternatives for gifting, including:

  • funneling taxable assets into an irrevocable trust
  • considering a Roth conversion to that will become an inherited Roth IRA, as distributions to the beneficiary are tax-free if left untouched for five years. Unfortunately, beneficiaries may not convert an IRA to a Roth IRA.
  • considering a charitable remainder trust

It may also be wise to examine options and the trust payout terms to avoid taxes on a lump sum payout after ten years.