As if planning for the future were not fraught enough, every so often new legislation comes along and changes up the rules. The SECURE (Setting Every Community Up for Retirement Enhancement) Act of 2019, which became effective at the beginning of 2020, instituted several changes related to retirement plans in general, as well as what happens to retirement accounts that are inherited. Although it might seem like you need to be an expert to navigate the new rules, in fact most people need to be aware of only a few changes; below, we outline these changes so that you can easily determine if any apply to you.
The changes made by the SECURE Act might impact you if:
To learn more about how the SECURE Act impacts these situations, read on.
Because the SECURE Act took effect on January 1, 2020, if you inherited a retirement account from someone who died before 2020, the old rules still apply to you.
The key takeaways of the SECURE Act are explained below. The first three changes affect contributions to and withdrawals from retirement accounts. The fourth change affects what will happen to your retirement account once you die and your beneficiaries—the people you've named to inherit the account—take ownership. (To learn more about different types of retirement accounts, see Estate Planning: IRAs and 401(k) Accounts.)
Prior to the SECURE Act, once you reached the age of 70 ½, you could no longer make contributions to a traditional IRA. Now, regardless of age, you can continue contributing to your traditional IRA, so long as you are still working. (Roth IRAs and 401(k)s did not have contribution age limits and remain unchanged.)
Before the SECURE Act was passed, you were generally required to begin withdrawing a certain amount of money each year—called a "required minimum distribution" or "RMD"—from your traditional IRA or 401(k) once you reached the age of 70 ½. The SECURE Act has pushed this starting age back to 72. In other words, it allows an extra year and a half for the money to grow in your retirement account tax-deferred. (Roth IRAs, unlike traditional IRAs, do not have RMDs, so you can leave your money in the account until any age.)
One exception, which remains unchanged by the SECURE Act, allows you to continue taking RMDs past the age of 72: if you are still working, have a 401(k) at your current company, and do not own 5% or more of the company, you can defer taking RMDs on that particular 401(k) until you retire. This exception would not apply to a 401(k) from a previous employer, only a current one.
Upon the birth or adoption of a child, each parent can now take $5,000 out of an IRA or 401(k) without incurring the early withdrawal penalty. (The penalty for withdrawing before the age of 59 ½ is usually an additional 10% income tax on the amount withdrawn.) From the date of the child's birth or the date the adoption becomes final, each parent has one year to withdraw up to $5,000; this applies for every child born or adopted into the family. At a later date, the parent can choose to "repay" this amount back into the retirement account by putting in the same amount over the contribution limit.
Generally speaking, taking advantage of the tax-deferred growth in a traditional IRA or 401(k) by leaving money in the account for as long as possible has financial benefits. This is true for those who inherit these accounts as well. Moreover, if beneficiaries have more control over their withdrawals, they might be able to wait until they are in a lower tax bracket to withdraw more money, or space out their withdrawals over many years to avoid being sent into a higher tax bracket due to one large withdrawal within a given year.
Unfortunately, the SECURE Act has shortened the withdrawal period available to non-spouse beneficiaries. (Beneficiaries who are spouses of the account holders have more options. To learn more about these options, read Naming Your Spouse to Inherit Retirement Accounts.) Previously, starting the year after your death, non-spouse beneficiaries were required to take a minimum amount out of the inherited account each year. This amount was based on the beneficiary's expected lifetime—the younger the beneficiary, the smaller amount. So if your 10-year-old grandson inherited your IRA, for example, the amount he would be required to withdraw each year would be quite small, relative to your 70-year-old sister. (The strategy of designating a young beneficiary was sometimes called a "stretch" strategy, for it stretched out the lifetime of your retirement account; you might have heard the term "stretch IRA" in the past.)
Now, the SECURE Act imposes a hard 10-year rule on non-spouse beneficiaries: they must withdraw the entirety of the account within 10 years of the account owner's death. They can take out as much or as little as they like before the 10-year deadline, but they must finish withdrawing everything within 10 years. However, there are exceptions for certain categories of beneficiaries, called "eligible designated beneficiaries," who can choose to withdraw amounts based on their expected lifetimes instead. Eligible designated beneficiaries include:
EXAMPLE: In New Mexico, seven-year-old Benny inherits his mother's 401(k). Under the new SECURE Act rules, he can make the minimum withdrawals based on his age until he turns 18, the age of majority in New Mexico, at which point he will have 10 years to withdraw the entirety of the 401(k). In other words, he will have to deplete the account by the time he turns 28.
EXAMPLE: Jessie names her brother Tad, who is five years younger than she is, as the beneficiary to her IRA. After Jessie dies, Tad can make withdrawals based on his own life expectancy.
Unless one of these exemptions applies, non-spouse beneficiaries who fail to follow the 10-year rule will incur a very hefty 50% penalty. So, for example, if you fail to withdraw the entirety of an inherited retirement account within 10 years, and $50,000 remains in it, you will owe a tax penalty of $25,000.
If you are one of multiple beneficiaries to a single retirement account, the situation gets more complicated, and it is usually a good idea to split the account among the beneficiaries.