What Happens to Your IRA (or Roth IRA) When You Die?

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An IRA (Individual Retirement Account) and Roth IRA have always been good options for accumulating savings to be used for retirement.

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But not everyone with a retirement account will need that money when they retire. Sometimes retirement savings may be more useful to other family members or friends after your death, such as for the education of a grandchild, providing for the special needs of a family member, or maintaining a family business for future generations. 

Additionally, IRAs offered significant tax advantages to you during retirement and then to any person you name as a beneficiary upon your death.

What Happens When Someone Inherits Your IRA or Roth IRA?

There are two different tax strategies that can be gained from different types of IRAs, depending on the type of money you save and submit.

Traditional IRA

The contributions you make to your traditional IRA are made before you pay taxes on that income—they are “pre-tax” contributions.

Therefore, with a traditional IRA, you receive a tax deduction up front, in the year the contribution is made, because the taxes you pay on that income are delayed until you withdraw that money as a deduction in retirement.

Roth IRA

Unlike the traditional IRA, the Roth IRA is funded with “post-tax” money, which means you are taxed on the money you contribute before you contribute it.

However, this means that when you withdraw that money in retirement, your tax rate on that withdrawal will be zero because you have already paid taxes on that money.

IRA tax advantages before 2019

Historically, when someone died and left their IRA account to a beneficiary other than their spouse, the beneficiary also benefited from the tax advantages. If the beneficiary of an inherited IRA were disciplined enough to do so, they could “stretch” the tax savings and asset protections that were available throughout the course of their lifetime. 

When someone used an IRA in this manner, it was commonly referred to as a “stretch” IRA. This has always been an effective estate planning resource for long-term tax savings. At the end of 2019, however, the rules for passing on the tax advantages of your IRA changed.

Until 2020, if the designated beneficiary were young, their life expectancy generally would be longer, which would make their annual required minimum distributions (RMDs) lower. In turn, they received greater deferred tax advantages.   

However beginning in 2020, Congress enacted the “Setting Every Community Up for Retirement Enhancement” (“SECURE”) Act. This was designed to provide greater access to retirement savings for employees rather than an estate-planning tool for passing on long-term tax benefits to non-retirees.

To accomplish this, the Act restricted the maximum time allowed for retirement plan payouts to 10 years. After 10 years, the entire plan must be paid out. So when any retirement plan participant died after December 31, 2020, any tax-deferred benefit was limited to ten years after the year in which the original participant died, even if the plan were inherited by a young and healthy beneficiary. 

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What Are the Consequences of the SECURE Act on Inherited IRA Beneficiaries?

Because the SECURE Act requires that all retirement benefits be paid out within ten years, there are several significant consequences for the beneficiaries of inherited IRAs:

  • Loss of ability to “stretch” deferred tax savings
  • Elimination of asset protection
  • Remainder distribution at 10-year term may create a significant income tax burden
  • Distributions become accessible to third-party beneficiaries

Although the SECURE Act still provides a 10-year window of possible tax savings, there is an obvious disincentive for impatient beneficiaries to defer disbursements to maximize tax savings.

To avoid this, there are several options still available for choosing an inherited IRA beneficiary that will optimize the available benefits.  

How Can You Make Sure the Right Person Inherits Your IRA?

Despite the restrictions that the SECURE Act implemented for inherited IRA beneficiaries, there are still options for making sure your chosen beneficiary obtains the benefits that remain available. 

Eligible Designated Beneficiaries (EDBs)

The SECURE Act does list out five categories of beneficiaries that are exceptions from the Act’s 10-year rule:

  • Surviving spouse
  • Disabled beneficiary
  • Chronically ill beneficiary
  • Minor children
  • Beneficiary not more than 10 years younger than the retiree

Choosing an EDB allows you to take advantage of the stretch to provide tax savings for the life expectancy of the beneficiary. However, your choice of qualified EDBs may be limited.

Life insurance

Dedicating accessible tax benefits to acquiring life insurance and naming an intended beneficiary can be akin to a stretch IRA.

The beneficiary will receive distributions upon the death of the retiree and the insurance plan can be designed to accomplish long-term estate planning goals for the beneficiary’s lifetime.

Consider life expectancy

For many, there may be no getting around the strict 10-year time limit of SECURE. However, there is still value in designating your inherited IRA beneficiary. Because your beneficiary is your choice, you can choose a younger beneficiary with a longer life expectancy, thereby minimizing the immediate RMD tax consequences and maximizing the accrued asset growth.

Whatever options you choose to counterbalance the effect of the SECURE Act restrictions, it is important not to look at your inherited IRA in isolation. Stretching the tax-deferred benefits of your IRA is only one possibility for accomplishing long-term objectives.

You should always evaluate your long-term estate planning options as a whole to balance the tax savings and asset protection goals that are right for you and your beneficiaries.

There Are More Options When It Comes to an IRA

If you plan to contribute to an IRA for the benefit of a non-spouse after your death, you can no longer stretch the asset protection and tax-deferred benefits of your plan beyond ten years past your death. This restriction, implemented within the SECURE Act, may give you pause for using your IRA as a long-term estate planning resource for a third-party beneficiary, like a child or grandchild. 

However, there are still advantages to providing an inherited IRA at your death. And what advantages are lost after 10 years because of the SECURE Act can be accommodated with other, creative estate-planning resources.  

Part of a comprehensive assessment of the effect of the SECURE Act on your long-term goals, specifically for your named beneficiary of your IRA, is obtaining advice from an attorney or estate-planning expert. Seeking creative alternatives requires insight into your current and future circumstances, as well as the circumstances of your intended beneficiary, and you play a significant role in that discussion. 

If you're looking to learn more about estate planning, read our guides on online will makers and when to update your will.

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