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You named your child or grandchild as beneficiary of your IRA

Posted On: NOVEMBER 2021

If you have a traditional IRA that designates your child or grandchild as beneficiary, be sure to consider the potential tax impact of the SECURE Act, which took effect in 2020. Previously, if you named someone other than your spouse as beneficiary, the recipient would have the ability to spread distributions over his or her life expectancy. He or she could then maximize tax-free growth while deferring, and often reducing, income taxes on distributions.

The SECURE Act limited the benefits of these so called “stretch IRAs.” Now, nonspousal inherited IRAs must be distributed to beneficiaries within 10 years (with certain exceptions).

This is not to say that naming a child or grandchild as beneficiary is a mistake. In many cases, they may be the most desirable recipients of your wealth, regardless of the 10-year distribution requirement. But if you chose your beneficiary before the SECURE Act was passed, you may want to consider alternatives that can reduce the tax impact on your family.

If you wish to defer distributions (and taxes) as long as possible, consider naming your spouse as beneficiary. Spouses still have the ability to take distributions over their life expectancies, or to roll over an inherited IRA into their own IRA and — presuming your spouse didn’t reach age 70½ before 2020 — defer distributions until they reach age 72.

If your spouse isn’t a beneficiary option, there are strategies you can use to achieve similar benefits to a stretch IRA. For example, you might leave your IRA to a charitable remainder trust (CRT) that makes payments to your child for life with the remainder going to charity.

Because a CRT is a tax-exempt entity, taxes are deferred until funds are distributed to a noncharitable beneficiary, so the benefits are similar to those provided by a stretch IRA. Of course, you’ll need to weigh those benefits against the cost of setting up the trust and leaving a portion of the funds to charity.

© 2021