You likely have taken an important step in your estate planning even if you haven’t started developing your will, trusts and other documents. That is designating the beneficiaries for your individual retirement accounts (IRAs). You do that on the accounts themselves with whatever financial institution, investment firm or other institution holds them.
You can still include this information in your will. However, if a beneficiary listed in your estate plan is different than on an account, the name on the account takes precedence.
Individual retirement accounts come with a lot of government regulations because of their tax-advantaged status. Some of those extend to the people who inherit them. That’s why it’s important to consider your IRA beneficiaries carefully so you don’t leave someone with an unintended tax burden.
How did the SECURE Act change the regulations for inherited IRAs?
The Setting Every Community Up for Retirement Enhancement (SECURE) Act, which took effect a couple of years ago, added a new restriction to inherited IRAs. Under the new law, unless a person qualifies as an eligible designated beneficiary, they have to take distributions on the full amount of the IRA (or the amount they’ve inherited) within ten years after they receive their inheritance. Since income taxes are paid on traditional IRAs at the time of distribution, that could mean a considerable amount of taxes over a decade.
Eligible designated beneficiaries have their estimated life expectancy to take their full distribution. (That was how it used to be for all beneficiaries prior to the SECURE Act.) For a younger person, that means they can take a relatively small amount each year and avoid a significant tax burden.
Who can be an eligible designated beneficiary?
The people who qualify as eligible designated beneficiaries are those who are considered to need the financial support an inherited IRA can provide. They include:
- Surviving spouses
- Disabled and chronically ill beneficiaries, if they meet specified requirements
- Non-spouses, as long as they’re less than ten years younger than the deceased
Minor children are also considered eligible designated beneficiaries. However, the ten-year distribution timeline kicks in once they become legal adults (at 18 in Colorado).
There’s a lot to consider when developing your estate plan. Too often, people who are trying to be generous to their loved ones end up causing them considerable expense and trouble. By having experienced legal guidance, you can avoid these unintended consequences.