by Daniel Kittell | Accounting News, IRS, News, Newsletter, Tax, Tax Planning, Tax Planning - Individual
Inheriting an IRA might feel like a financial win, but the rules today are different than they were just a few years ago. If you’re not up to date, an unexpected tax bill could catch you off guard. Here’s what changed, and how to plan around it.
Changes Made by the SECURE Act
The SECURE Act of 2019 eliminated the “stretch IRA,” which allowed inherited funds to grow tax-deferred for decades while keeping annual withdrawals relatively low. Now, many non-spousal heirs must withdraw the entire inherited IRA within 10 years of the original owner’s death.
This is the 10-year rule, and it can be a tax trap for non-spouse beneficiaries.
If the IRA is traditional, any withdrawals are taxed as ordinary income. If you wait and withdraw everything in year 10, it could push you into a much higher tax bracket.
Who Gets a Pass from the 10-Year Rule?
Not everyone is subject to the 10-year rule. The IRS created a category called “eligible designated beneficiaries.” Beneficiaries in this category can still stretch distributions over their life expectancy. They include:
- A surviving spouse
- A minor child of the deceased IRA owner (until reaching adulthood)
- A disabled beneficiary
- A chronically ill beneficiary
- A beneficiary who is no more than 10 years younger than the original owner
A surviving spouse has the most flexibility. They can roll the inherited IRA into their own IRA and treat it as their own account, which allows them to follow standard RMD rules based on their age.
Minor children who inherit an IRA can take RMDs based on their life expectancy until they reach age 21. After that, the 10-year rule kicks in.
Why the 10-Year Rule Can Be a Problem
The 10-year rule can be problematic for tax purposes. If you inherit an IRA with significant funds and you’re forced to withdraw it within 10 years, those withdrawals could push you into a higher tax bracket. And that, of course, means paying more to the IRS than necessary.
It’s important to note that the 10-year rule enacted in the SECURE Act only applies to IRAs inherited in 2020 and beyond. If you inherited an IRA before 2020, you’re still covered under the old rules.
How to Avoid the Tax Trap
The key is in planning. Don’t wait until the ninth year to make withdrawals. Instead:
- Spread withdrawals over the 10-year period to manage your tax bracket.
- If possible or applicable, coordinate distributions with lower-income years.
- Work with a tax advisor to help you work through different withdrawal strategies.
Here’s the bottom line: the SECURE Act changed the rules for inherited IRAs, and without careful planning, the 10-year requirement can create significant tax bills for beneficiaries. Be prepared, understand the timing, and work with a tax professional to reduce the impact.
by Daniel Kittell | Accounting News, Business Consulting, News, Tax Planning, Tax Planning - Individual
The Setting Every Community Up for Retirement Enhancement (SECURE) Act changed the rules for employers on retirement plans, making it easier for employers to offer 401(k) plans and for employees to take part in them. Here’s how.
Multiple Employer Plans
Known as MEPs, multiple employer plans permit businesses to band together to offer employees a defined contribution plan such as a 401(k) or SIMPLE IRA, effectively allowing workers access to the same low-cost plans offered by large employers. While MEPs existed before the SECURE Act, here’s how they are now easier to establish and maintain.
- The “one bad apple rule”, where one employer’s failure to comply jeopardized the entire plan, was done away with.
- The “common nexus” requirement, which restricted the MEP option to small business employers who operated either in the same industry or same geographic location, was eliminated, permitting an “open MEP” that can be administered by a pooled plan provider (typically a financial services firm).
- MEPs with fewer than 1,000 participants (and no more than 100 participants from a single employer) are excluded from a potentially expensive audit requirement.
- Small business employers are also eligible for new tax credits for offering retirement savings options to employees.
Changes to Safe Harbor Plans
A provision of the SECURE Act provides more flexibility for employers who offer safe harbor 401(k) plans, which are 401(k) plans with an employer match that allows for avoidance of most annual compliance tests. If a 401(k) includes a Safe Harbor provision, the employer makes annual contributions on behalf of employees, and those contributions are vested immediately. Flexibility offered by the SECURE Act includes:
- Increasing the automatic enrollment escalation cap under a qualified automatic contribution arrangement (QACA) 401(k) plan from 10 to 15%.
- Removing the notice requirement for nonelective contributions. (The notice requirement is still applicable, however, for plans that implement the safe harbor match.)
- Whereas pre-SECURE Act, switching to a safe harbor plan had to be done before the start of the plan year, employers are now allowed to switch to a safe harbor 401(k) plan with nonelective contributions anytime up to 31 days before the end of the plan year. Amendments after that time are approved if (1) a nonelective contribution of at least 4% of compensation is granted for all eligible employees for that year, and (2) the plan in amended by the close of the following plan year.
Automatic Enrollment Credit
The SECURE Act added an incentive for small businesses to feature automatic enrollment in their plans by allowing businesses with fewer than 100 employees to qualify for a $500 per year tax credit when they create a new plan that includes automatic enrollment. Business can also take advantage of this by converting an existing plan to one with an automatic enrollment. The tax credit is available for three years following the year the plan automatically begins enrolling participants.
Part-Time Employee Participation
Previously, employers could exclude employees who work fewer than 1,000 hours per year from defined contribution plans, including 401(k) plans. Starting in January of 2021, the SECURE Act requires employers to include employees who work at least 500 hours in three consecutive years. This means that in order to qualify under this rule, employees would need to meet the 500-hour requirement for three years starting in 2021 in order to become eligible in 2024.
Choosing the Right Plan for Your Business
- Research 401(k) plan options for your business, keeping in mind that retirement plans can be customized to meet the needs of you and your employees.
- Carefully read through costs and fees of each plan. Recordkeeping fees, transaction fees, and investment fees are some to be mindful of, and these fees might increase if you add more employees and the plan grows (i.e. low-cost plans upfront might not be the best plan for your business in the long term.)
- Look for a 401(k) plan that presents a variety of investment opportunities for employees in terms of stocks, bonds, broad-based international exposure, and emerging markets.
Work with a financial expert who can help you establish and oversee a 401(k) plan. These professionals can include third-party administrators, recordkeepers, and investment advisors and managers.
