It’s important to review your beneficiary designations on your retirement plans and life insurance every few years to make sure the people you want will inherit the money — especially if you’ve experienced any major life changes. Your beneficiary designations supersede anything you’ve specified in your will. That means if you were married or divorced and updated your will but not your beneficiary designations, your retirement accounts and life insurance would still go to the beneficiaries you had originally specified on those accounts.
If you started working before you were married and you designated your parents as the beneficiaries of your life insurance or retirement plan, don’t forget to update your beneficiary designations to your spouse. Also update the beneficiary designations after you get divorced — otherwise, your ex-spouse could inherit the accounts. As you get older and start to consider more complex estate plans — which may include leaving some money to grandchildren and charities — it’s a good idea to work with an estate-planning attorney who can help you support the organizations or your heirs in the most tax-efficient way.
It’s particularly important to review beneficiary designations for your IRAs and 401(k)s this year because the SECURE Act, a law passed in December 2019, made some major changes to the withdrawal options for beneficiaries. Some strategies that worked well in the past and could have helped your heirs spread out their withdrawals (and the tax bills) over their lifetimes, are no longer an option.
New Inherited IRA Rules
If your beneficiary is your spouse, he or she has always had different withdrawal options than non-spouse beneficiaries. A surviving spouse who inherits a traditional IRA or 401(k) can roll the money into his or her own account and postpone taking required withdrawals until age 72. This option lets them delay taking withdrawals — and paying the tax bills –for a longer time period. However, they may have to pay a 10% early-withdrawal penalty if they take the money before age 59 ½, as they would with their own IRA withdrawals. Or they can transfer the money to an inherited IRA, where they won’t have an early-withdrawal penalty, but they must take required minimum distributions every year starting in the year the original IRA holder would have turned 72.
The rules are different for non-spouse beneficiaries, such as your children, grandchildren, siblings and others. In the past, they had to take required minimum distributions from the inherited IRAs and 401(k)s, but they could spread out those withdrawals (and the tax bill on the withdrawals) over their lifetimes, a strategy known as a “stretch IRA.” But the SECURE Act changed those rules for people who inherit an IRA or 401(k) from someone who dies after December 31, 2019. Now most non-spouse beneficiaries must withdraw all of the money from the IRA within 10 years of the original owner’s death. The money can be withdrawn at any time within that 10 years — they don’t have to withdraw a certain amount each year as they had to in the past — but they must withdraw the entire amount by the end of the 10th year. There is no 10% early-withdrawal penalty when they withdraw money from an inherited IRA before age 59 ½.
This new 10-year rule is a big change for some people who planned to leave their IRAs to their grandchildren and enable them to stretch the required distributions and tax bills over several decades. The longer you can delay taking withdrawals from the inherited IRA, the longer the money can grow tax-deferred in the account. There are some exceptions to the 10-year rule, such as minor children of the original IRA holder until they reach the age of majority (but not grandchildren), and some beneficiaries who are disabled or chronically ill. These “eligible designated beneficiaries” have the option to take required minimum distributions based on their life expectancy.
The rules also changed for Roth IRAs. Non-spouse beneficiaries must generally withdraw money from inherited Roth IRAs within 10 years, too, but the withdrawals are usually tax-free.
It’s always important to review your beneficiary designations for your retirement plans and life insurance to make sure they’re up to date with your wishes. And because of these changes to the inherited IRA rules, it’s particularly important to review those beneficiary designations this year.
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