When you spend a lifetime building a nest egg, your primary goal is often to leave a lasting legacy for your children. Most retirees assume that when they pass away, their kids will inherit 100% of their Traditional IRA.
Unfortunately, under current tax laws, that is no longer the reality.
Thanks to major legislative changes, your traditional retirement accounts could actually turn into the single largest tax liability you pass on to your next of kin. Here is what you need to know about the changing rules of inherited IRAs and how you can protect your family from a massive tax bill.
Prior to 2020, if your children inherited your IRA, they could use a strategy known as the “Stretch IRA.” This allowed them to take small, incremental distributions based on their own life expectancy. By spreading the withdrawals over several decades, the tax hit was minimal, and the money could continue to grow tax-deferred.
However, the passage of the Secure Act fundamentally changed the landscape. For anyone inheriting a retirement account as a non-spouse beneficiary, the Stretch IRA is gone.
Under the current Secure Act IRA rules, most non-spouse beneficiaries—including your children—have a strict 10-year deadline to completely empty the inherited retirement account.
While a decade might sound like a long time, the timing of this rule creates a perfect tax storm. If you live into your 70s or 80s, your children will likely be in their 40s or 50s when they inherit your account. These are statistically their peak earning years.
By forcing your children to take massive distributions from your IRA on top of their already high salaries, the government ensures it takes the highest possible tax rate. Instead of a blessing, your IRA could push your kids into a much higher tax bracket, forcing them to hand over a massive chunk of their inheritance to the IRS.
If you want to bypass this compressed timeline and save your children from a crushing inherited IRA tax liability, the burden falls on you to take the tax hit first.
The most effective way to do this is through strategic Roth conversions during your retirement years—specifically before you are forced to take your own Required Minimum Distributions (RMDs).
By systematically converting your Traditional IRA into a Roth IRA, you pay the income tax now at your current effective tax rate. Because Roth IRAs grow tax-free, your children will eventually inherit an asset that they can withdraw completely tax-free. Even though they are still subject to the 10-year withdrawal rule, the distributions will not trigger a massive income tax bill.
Protecting your hard-earned wealth and your family’s financial future requires more than just standard estate planning documents. It demands proactive retirement tax planning.
Don’t let the IRS become the primary beneficiary of your retirement account. Call our office at 919-659-8433 for a free discovery call and initial attorney consultation.
Or directly schedule a free discovery call at your convenience: calendly.com/caryep/discovery-call-get-started-cep-blog
Paul Yokabitus is the CEO and Managing Partner of Cary Estate Planning, a Cary, NC, estate planning law firm. With years of experience in estate and elder law, he has zealously represented clients in various legal matters, including estate planning, guardianship, Medicaid planning, estate administration, and other cases.
Paul received his Juris Doctor from the Campbell University School of Law and is a North Carolina Bar Association member. He has received numerous accolades for his work, including being named among the “Best Attorney in Cary” in 2016 and 2017 by Cary News and Rising Star in 2020-2023 by Super Lawyers.