SECURE Act rewrites the rules on stretch IRAs

Key takeaways

  • For many who inherit IRAs or 401(k)s starting in 2020, the SECURE Act eliminated the ability to "stretch" your taxable distributions and related tax payments over your life expectancy.
  • If you've inherited an IRA on or after January 1, 2020, and you cannot stretch your distributions, you may need to withdraw the balance of the account no later than the 10th anniversary following the calendar year of the IRA owner's death.
  • There are 3 possible strategies to consider based on your situation: (1) withdraw the assets as evenly as possible over the 10 years, (2) wait until the end the of the 10-year period and then withdraw everything, and (3) make irregular withdrawals over the 10-year period.

In December 2019, Congress passed the Setting Every Community Up for Retirement Enhancement (SECURE) Act. The act includes many reforms that could make saving for retirement easier and more accessible for many Americans. But there is one potential downside: If you inherit an IRA or 401(k) from someone other than your spouse, the SECURE Act could impact your retirement savings plans or strategies to transfer wealth to future generations.

Prior to the act, if you inherited an IRA or 401(k), you could generally "stretch" your taxable distributions and tax payments out over your life expectancy. Many people have used "stretch" IRAs and 401(k)s as a reliable lifetime income source.

Now, for IRAs inherited from the original owners who passed away on or after January 1, 2020, the new law requires most beneficiaries to withdraw assets from an inherited IRA or 401(k) plan within 10 years following the death of the account holder.

The IRS' proposed regulations on required minimum distributions (RMDs) published on February 24, 2022 would require distributions to be made on an "at least as rapidly" basis during the 10-year period and then a complete distribution in year 10, provided the deceased employee or IRA owner had already begun taking RMDs. If you have not already started taking distributions, the IRS has waived the penalty for failing to take RMDs in these instances for tax years 2020-2024.1

The exceptions

Generally speaking, people who inherit an IRA or 401(k) from their spouse can stretch out their required minimum distributions (RMDs) over the course of their lifetime. The SECURE 2.0 Act of December 2022 expanded on this benefit for spousal beneficiaries of retirement plans such that those beneficiaries could elect to be treated as the original employee, allowing for the use of more advantageous RMD tables. You may also able to stretch distributions if you fall into one of 3 other common types of eligible designated beneficiaries (EDBs):

  1. A minor child (not grandchild) of the original owner2
  2. Someone who is not more than 10 years younger than the original owner
  3. Someone disabled or chronically ill (as defined under the applicable sections of the Internal Revenue Code)

If you’re eligible, stretching distributions makes sense because doing so maximizes the value of tax deferral.

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3 scenarios to consider

If you're not a spouse or an EDB, then generally you must distribute all assets from the inherited IRA within 10 years of the original owner's death. How should you do this? In general, it depends on which of 3 scenarios below best describes your situation.

Scenario 1: You inherit a traditional IRA or 401(k), need the income to live on in retirement, and expect your tax status or taxable income to remain constant over the next 10 years

How to withdraw

In this scenario, it's often advantageous to withdraw assets from the inherited IRA or 401(k) in equal installments over the entire 10-year period. The strategy is designed to smooth out the impact of additional taxable income and help lower the risk of bumping you into a higher marginal tax bracket by mistake.

How to invest

If you have assets other than the inherited account dedicated to the same goal, and you're willing to complicate things a bit in order to potentially reduce your total tax bill, it may be smart to invest more of your bond or cash allocation to the inherited account.

For example, say you inherited a traditional IRA worth $100,000 and you've decided to use it for your retirement goal. The assets are currently held in a mutual fund with a balanced (50/50) asset allocation, which is generally aligned with the asset allocation of your other assets earmarked to fund your retirement.

Assuming you are comfortable operating within your current risk profile (and won't change it as you edge closer to retirement), you might consider holding assets with lower growth potential in your inherited IRA; then you could invest remaining assets with a higher growth potential (such as stocks or equity ETFs and mutual funds) in non-inherited retirement accounts so that your total asset allocation remains 50/50. That way, you could potentially defer paying ordinary income taxes on a relatively large portion of the growth in your assets assigned to the goal for a longer period of time, as the assets in the non-inherited retirement accounts don't need to be withdrawn within the 10-year window.

Scenario 2: You inherit a Roth IRA or Roth 401(k) and expect your tax status or taxable income to remain constant over the next 10 years

In this case, the better withdrawal and investment strategy is likely the opposite of that in Scenario 1.

How to withdraw

Generally, keeping assets in inherited Roth accounts for as long as possible may help you earn your highest returns because qualified withdrawals are tax-free.

How to invest

If you have non-Roth assets dedicated to the same goal and you're willing to complicate things a bit in order to potentially reduce your total tax bill, it may be smart to invest the inherited account with higher growth potential assets—and the remaining accounts in the goal with lower growth potential assets. That way, you can reduce your total tax bill by generating more growth in the Roth account, which is not taxed.

Scenario 3: You inherit a Roth account and expect a significant change in your tax status or taxable income

What might be a significant change? Here are 3 examples:

  1. You plan to retire over the next few years and you anticipate your income declining
  2. You are planning to move from a high income tax state (like California, New York, or New Jersey) to a low income tax state (like Florida, Texas, New Hampshire, or Washington), or vice versa.
  3. Your taxable income is expected to increase; for example, you expect to start receiving additional taxable income from rental real estate, business consulting, Social Security, or other sources.

How to withdraw

In this case, it may make sense to make irregular withdrawals over the 10-year window, in order to smooth out your taxable income and tax liability as much as possible. For example, if you plan to move from New York to New Hampshire when you retire (and are no longer receiving a salary) in 5 years, the bulk of your withdrawals could be planned to take place in years 6 to 10, after your income is lower and you've moved to a state without income taxes.

How to invest

As in Scenario 2, if you have non-Roth assets dedicated to the same goal, it may be smart to invest the inherited account with higher growth potential assets—and the remaining assets with lower growth potential assets.

Talk to us

If you are the owner or inheritor of an IRA or other qualified retirement plan, you may wish to take some time to consider how the SECURE Act may impact your own retirement accounts along with your beneficiaries and reevaluate your retirement, estate planning, and gifting strategies.

Work with your financial professional to help clarify your personal and financial goals. Remember, your plans should evolve as you do.

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More to explore

1. See IRS Notice 2022-53, 2023-54, and 2024-35. 2. 10-year clock begins once minor child of the original owner reaches age of majority.

For a distribution to be considered qualified, the 5-year aging requirement has to be satisfied, and you must be age 59½ or older or meet one of several exemptions (disability, qualified first-time home purchase, or death among them).

The change in the RMDs age requirement from 72 to 73 applies only to individuals who turn 72 on or after January 1, 2023. After you reach age 73, the IRS generally requires you to withdraw an RMD annually from your tax-advantaged retirement accounts (excluding Roth IRAs, and Roth accounts in employer retirement plan accounts starting in 2024). Please speak with your tax advisor regarding the impact of this change on future RMDs.

Recently enacted legislation made a number of changes to the rules regarding defined contribution, defined benefit, and/or individual retirement plans and 529 plans. Information herein may refer to or be based on certain rules in effect prior to this legislation and current rules may differ. As always, before making any decisions about your retirement planning or withdrawals, you should consult with your personal tax advisor.

Fidelity does not provide legal or tax advice. The information herein is general and educational in nature and should not be considered legal or tax advice. Tax laws and regulations are complex and subject to change, which can materially impact investment results. Fidelity cannot guarantee that the information herein is accurate, complete, or timely. Fidelity makes no warranties with regard to such information or results obtained by its use, and disclaims any liability arising out of your use of, or any tax position taken in reliance on, such information. Consult an attorney or tax professional regarding your specific situation.

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