What Does the SECURE Act Mean for Your Family’s Inheritance?

There are few things that people worry about more than security when they approach retirement. Will I have enough to live comfortably? Will I be able to stop worrying about my finances? Will I be able to pass a comfortable legacy on to my family? 

It’s no wonder, then, that the newest legislation concerning retirement is called the SECURE Act. Signed into law on December 20, 2019, the act aims at “Setting Every Community Up for Retirement Enhancement.” Yet for many people, the actual impact of the law is unclear. 

There are many parts and provisions to the act, and more of its effects are sure to emerge as the law comes into play. So far though, the majority of concerns I’ve fielded from clients have to do with the effects of SECURE on the way people inherit IRAs. Whether you’re saving for retirement or stand to inherit a family member’s estate, it’s important to understand what the SECURE Act changed and how it affects your future plans. 

Before the SECURE Act

When my brother-in-law passed away in 2019, I inherited half of his IRA. Because I was a non-spouse beneficiary, I had the option of taking “stretch distributions.” That meant that I could withdraw a small portion of the funds each year, stretching it out until I was 85, 90, or 95 years old—I could draw it out over my lifetime. 

The rate at which you had to take distributions was based on your life expectancy, as determined by IRS actuarial tables. You were required to pull a little bit out each year, but the overall time frame for disbursement was generous. For example, if you inherited an IRA when you were 20, you might have up to 65 or 70 years to withdraw everything. If you were older, the time frame was shorter, but it was still expansive enough to account for a lengthy disbursement schedule. 

Stretch disbursement allowed beneficiaries to minimize their tax burden, and they were also able to leave more money in the IRA so it could continue to experience compounded growth. In essence, this financial strategy sheltered inherited income and allowed it to grow for future generations. 

The SECURE Act’s Changes

Under the SECURE Act, stretch disbursements are no longer possible. Regardless of how old you are when you inherit, you have a maximum of ten years to pull all the money out of the IRA. It’s no longer possible for the money to compound tax-deferred across generations. 

The other significant change relates to the withdrawal requirements. Under the old system, inheritors were required to pull money from the IRA each year, but the SECURE Act doesn’t require a minimum withdrawal. In other words, you don’t have to take money out each year, as long as you have it all out by the end of the ten-year period. 

These changes require more up-front financial planning. For example, my parents are in their eighties, and while I hope I don’t inherit anything anytime soon, I know that when I do, I will have limited flexibility on how I take distributions from my Dad’s IRA and the impact it will have on my taxes. I don’t want that whole amount added to my income in a single year because that would push me to a higher tax bracket. 

Instead of having decades to spread the tax burden out, though, I will only have ten years of flexibility. Because of the SECURE Act, it’s important to start developing an action plan immediately because, time-wise, your flexibility is now much more restricted. 

Thanks to the new withdrawal rules, though, you do have a little bit of wiggle room. For example, if you know that you’re in a higher tax bracket the year you inherit an IRA, you might want to wait a year before you pull any funds out of the account. Alternatively, you could decide to even out your tax burden by distributing it evenly across the ten-year period. 

For example, if you’re married, filing taxes jointly, and make $100,000 per year after deductions, you fall into a 22% tax bracket. 

Let’s say that you inherit a $500,000 IRA. If you take it all at once, that pushes you up to a 24% tax bracket. You’ll be paying more, at a higher rate. 

To remain in the 22% bracket, you can only earn up to $168,000 per year. It might make more financial sense to withdraw $68,000 per year, spread the tax burden over time, and pay the taxes annually at 22%.

If you aren’t on top of your game though, you run the risk of having to pull large amounts out at the end of the ten years. In that case, you would be facing a large lump tax burden. 

How This Changes Investment Options

Under the old system, you might have had a forty-year investment horizon, which means that you could take on more equity exposure. With the SECURE Act’s shorter timeline, you may not want to do that because if the account grows quickly it could raise your taxes. You have to consider how the inherited money fits into your overall financial plan and whether your circumstances allow for more growth within the IRA or to instead invest for more growth in other accounts. 

In some ways, it’s counterintuitive. Of course everyone wants to grow their money. But if the rate of growth is too fast, you may end up paying more taxes than the amount you earn from the additional equity. 

You also might have to change your preferred investment categories or where you use different types of investments. For example, if your tax bracket doesn’t allow you much room for growth within the IRA, it might make more sense to invest more of  the funds within the IRA into bonds, which are slower-growing than stocks. 

In sum, the shortened ten-year window makes it even more important to consider the interplay of all your financial factors—and to do so quickly!

How This Changes Retirement Behavior

These changes could also potentially affect how people distribute their own IRAs. For example, if you are in a lower tax bracket than your beneficiaries, you might try to withdraw more than the minimum to ensure the money is taxed at a lower rate. 

Furthermore, with the option of stretch distribution off the table, IRAs might be less attractive for families looking to grow their multi-generational wealth. During their estate planning, individuals might seek more flexible inheritance options. 

The SECURE Act means that IRA owners need to think more globally about their investments. When they distribute their IRA, they aren’t just affecting their own retirement finances. They are also affecting the options of their beneficiaries. The shorter time frame means that families need to develop a multi-generational tax plan. 

Don’t Delay

The SECURE Act has a number of other provisions, so we’re just starting to scratch the surface about how it will affect financial planning in the long run. Regarding this particular aspect, though, I have one main piece of advice for clients: 

When you find out that you’re the recipient of an inherited IRA, immediately take action. With financial matters, time is often of the essence, but that’s especially true in this case. You can’t wait three years to find out what will work best for you over that ten-year horizon. If you and your family can make IRA discussions part of your estate planning process, that’s even better. 

Every family wants to be secure, but more than any specific provision of law, true security comes from sound financial planning. Knowing what the SECURE Act means for your family will help you make the best decision possible.