By Julia Dean, J.D., and William Harlow, J.D.
If you are like most people, your retirement account is probably one of your largest assets. During your lifetime, being able to defer income taxes on funds placed into your retirement account is a huge financial benefit. The government wants to encourage you to put aside money for your retirement. You used to get a similar tax-deferred or tax-free benefit when your retirement funds were given to your loved ones upon your passing, but this has changed. “Uncle Sam” saw an opportunity to grab billions in taxes by shortening the timeframe your loved ones can defer income taxes when they inherit your retirement account. Your “Uncle” seized that opportunity.
The Setting Every Community Up For Retirement Act (“SECURE Act”) went into effect January 1, 2020, which was later clarified and modified in 2023, with the so-called “SECURE Act 2.0”. This Act dealt a major blow to your estate planning when using retirement funds for generational wealth building. The magic of the ability to “stretch” out the delayed income taxes over your loved one’s life expectancy—all while the account was compounding tax-deferred or tax-free—disappeared for most beneficiaries. Now, your loved ones will have a much shorter period of time to allow the account to compound tax-deferred or tax-free. The magic isn’t completely gone, but is it significantly diminished.
Now, the SECURE Act replaced the “stretch” distribution rule with the 10-year mandatory distribution rule. Just as it sounds, your loved ones will have to distribute and pay any taxes on your entire retirement plan within just 10 years. The SECURE Act provides some exceptions to the 10-year mandatory distribution rule, where the “stretch” rule will still apply: your beneficiary is a spouse, a minor child (until age 21), chronically ill, disabled, or is not more than 10 years younger than you.
Assuming no exceptions apply, your entire retirement account would be distributed in 10 years and would be exposed to your loved one’s liabilities and creditors. However, there are steps that you can take now to protect your retirement when you give it to your loved ones upon your passing.
A Retirement Inheritance Trust (RIT) is a specialized trust designed to receive retirement funds in inheritance. If you have a retirement account, an RIT can be an effective tool for your legacy plan. The RIT provides several important protections for your loved ones, namely: (1) asset protection, (2) divorce protection, and (3) keeping the funds from being included in your loved one’s estate for estate/death tax purposes.
If you are interested in discussing the best possible options for passing your retirement account on to your loved ones, you should consult with an experienced estate planning attorney. Your legacy can be secured and amplified with proper planning.