If you have an IRA, 401K, or other deferred compensation retirement account- LISTEN UP [View all]

[nitpicker]

If you have an IRA, 401K, or other deferred compensation retirement account- LISTEN UP


Your beneficiaries may have to take out all the money (and pay taxes on it) within 10 years of your death.

I didn’t know about this until an association e-mailed me that there would be a speaker on ”Securing your Wealth under The SECURE Act”.

I Googled it, and found “SETTING EVERY COMMUNITY UP FOR RETIREMENT ENHANCEMENT” had been incorporated into the provisions of HR 1865, aka Public Law 116-94.

The text https://www.congress.gov/bill/116th-congress/house-bill/1865/text?format=txt contains (Division O, near the end) various provisions about retirement accounts.

DUers previously noted https://www.democraticunderground.com/100212826849 certain benefits of those provisions (1. If you hadn’t reached 70 ½ yet by 31 Dec 2019, the deadline for starting required minimum distributions is now 1 Apr the year after the year you reach 72; 2. You can contribute to a traditional IRA if you are working past 70 ½).

HOWEVER, Congress decided to raise revenues.

If somebody died before 1 Jan 2020, the rules didn’t change. BUT the rules changed for many of those who are, or will become, beneficiaries of those who died after 31 Dec 2019. There are exceptions for surviving spouses, beneficiaries (e,g, parents, siblings, cousins, others) no more than 10 years younger than the account owner, disabled and chronically ill persons, and minor children (not grandchildren). However, once minor children reach maturity, whatever is left has to be distributed within 10 years.

For the other beneficiaries of those who have/will die after 31 Dec 2019, one analyst said https://www.myfederalretirement.com/inherit-iras/ the new rules of those beneficiaries having to withdraw within 10 years of death apply not just to Traditional IRAs, but also to Roth IRAs, regular 401Ks, TSPs that get rolled over into “inherited” IRAs, and other deferred compensation retirement accounts. ((TSP is officially still considering if the SECURE Act does apply to it, and TSPs that don’t get rolled over into IRAs must be withdrawn within 5 years.))

These other beneficiaries NO LONGER have the option to stretch payments (and taxes) over their lifetime. Instead, the money has to be distributed to them within 10 years. (There IS the option to have a lump sum at the end of 10 years, but someone suggests this only be done if it’s a Roth IRA or Roth inherited IRA.)

Impact: Granny dies after 31 Dec 2019 and her 60-year-old kid is the beneficiary of $25,000 traditional IRA/401K/etc.

In the first year, under the old rules, this non-exempt beneficiary would have had to take distributions of (at least) $1000 (numbers rounded) and pay income tax on it. Assuming single in a decent job, that’s 22% tax due on it, or $220 on $1000.

If the beneficiary wanted to evenly spread the distribution over the 10 years under the new rules, the annual withdrawal would be $2500. That raises tax due on that to $550.

((plus state taxes))

Double the account amount? Double the federal tax due (on $5000 withdrawn evenly each year) to $1100. The IRS becomes VERY Interested it people fall behind on timely paying of taxes by $1000 or more. The beneficiary should either (1) have the “IRA Custodian” (e.g. bank) withhold the tax due on the distribution, or (2) pay the IRS, via estimated taxes, the applicable tax due no later than the 15th of the month after the calendar year quarter in which the distribution was made.

Let’s not forget the impact on Social Security taxation. Taxable IRA/401k/etc. benefits are counted as income. Unless the beneficiary already has a pension so generous that a full 85% of SS benefits is already taxable, the IRA/etc amount distributed in a year can increase the amount of taxable SS benefits.

Example: The elderly account owner leaves a $250,000 balance in a regular 401k. A non-exempt beneficiary spreading it out over 10 years will have to take distributions averaging $25,000 a year. This will almost certainly cause some (or all) of any SS benefits received to become more-taxable (again unless the other pension/income is so generous that 85% of SS is already taxable). Plus there will be federal income tax due (on a distribution of $25,000 at 22%= $5,500).

In short:

1. It usually doesn’t work anymore to choose a much younger beneficiary ((e.g. adult grandkid)) versus their parent;
2. If you are an account owner, you may want to find some way to ensure beneficiaries can pay distribution taxes;
3. If you are/will be a non-exempt beneficiary, plan on how to handle the accelerated distributions and taxes.