Naming Beneficiaries after the Passing of the Secure Act

The Secure Act was passed on December 19, 2019, and it made a significant change to the “stretch” provision for most non-spouse designated beneficiaries for retirement accounts, including 401(k), IRA, Roth IRA, and other pre-tax or post-tax retirement plans. Prior to the Secure Act, beneficiaries could receive their distributions from the retirement accounts over their life expectancy. This meant, even with large retirement accounts, beneficiaries could often stretch distributions over 30 or 40 years. However, under the Secure Act, with a few exceptions, beneficiaries must take distributions within 10 years. Assuming the participant dies when he or she is in their 80s, there is a good chance that the beneficiary child may be in his or her 50s or 60s. This creates the perfect storm from an income tax perspective because this is often when the child is at his or her highest earning potential while at the same time now forced to receive distributions from pre-tax retirement plans.

What are some options to minimize income taxes to your children?

• Deciding when to take distributions. Although distributions must be taken within 10 years after the date of death, those distributions can be taken at any point over the ten year period, including 100% of the distributions at the end of year 10. By taking distributions at the end of the 10 year term, the retirement accounts will grow tax-deferred until the distributions are made. This strategy may not always work depending upon the beneficiary’s income over those years. Each beneficiary should work with their SageMint Wealth advisor to determine the appropriate time to take distributions.
• Roth Conversion. If the participant can afford to convert their 401(k) or IRA to a Roth IRA during the participant’s lifetime, it could save the beneficiary significant taxes in the future. This strategy requires careful planning of not only the participant’s taxes, but also the beneficiary’s anticipated taxes in the future. Although a Roth IRA is required to make distributions over the same 10 year period, the beneficiary will receive those distributions tax-free. As explained above, even with a Roth IRA, it may be advantageous for the beneficiary to take the distribution of the Roth IRA at the end of year 10.Traditional IRA account owners have considerations to make before performing a Roth IRA conversion. These primarily include income tax consequences on the converted amount in the year of conversion, withdrawal limitations from a Roth IRA, and income limitations for future contributions to a Roth IRA. In addition, if you are required to take a required minimum distribution (RMD) in the year you convert, you must do so before converting to a Roth IRA.
• Naming your children as primary beneficiary before your spouse. Traditionally, married couples will name their spouse as the primary beneficiary of their retirement account. The problem with this approach is that the deceased spouse’s retirement accounts will pass to the surviving spouse‘s retirement accounts and when the surviving spouse passes, all of the retirement accounts will pass to their children over a 10 year period. However, if the surviving spouse does not need the distributions from the retirement accounts, it may be more advantageous to distribute that account to the children while the surviving spouse is still living. This strategy will allow the children to stretch out their parents’ retirement accounts over two different periods, rather than receiving both parents’ retirement accounts over the same 10 year period.
• Naming a charity as a beneficiary of your retirement account. If you are charitably inclined, you may want to consider naming a charity as a beneficiary of your retirement account instead of other assets. The advantage of naming a charity as the beneficiary of a retirement account is that a charity does not pay income taxes. Therefore the distributions from the retirement accounts will pass to the charity tax-free. If you have other non-charitable beneficiaries, they could receive the non-retirement account assets. It is possible to name charitable trusts, such as a charitable remainder trust, as a beneficiary of a retirement account in order to receive some of these same tax benefits while still providing for family members.

Each of these strategies are fact dependent and require a deep analysis of your tax situation, retirement goals, spending needs, and family dynamics. At SageMint Wealth we work closely with our clients and their family to optimize not only retirement planning for the near future but also for generations to come.