The Secure Act 2.0 brought a series of changes that directly impact how families plan for the future of their disabled loved ones. Understanding these updates is crucial if you’re looking to ensure a secure financial foundation for a disabled family member.
With some new provisions tailored explicitly to beneficiaries with disabilities, Secure Act 2.0 offers tools to optimize your inheritance strategy.
What Does Secure Act 2.0 Mean for Inherited IRAs?
Secure Act 2.0 continues and refines the work of the original Secure Act by altering required minimum distributions (RMDs), updating inheritance rules, and introducing beneficiary-specific protections.
The first Secure Act raised the age at which retirement account holders must begin RMDs and set guidelines for inherited IRAs that significantly impacted non-spousal beneficiaries. Under the new law, more options have been added, especially for disabled beneficiaries.
The “10-year rule” for non-eligible designated beneficiaries, a cornerstone of the original Secure Act, still applies in most cases. Non-spousal beneficiaries must withdraw inherited IRA assets within ten years of the original owner’s passing. For most beneficiaries, this change removes the “stretch IRA” strategy that allowed funds to grow tax-deferred over the beneficiary’s lifetime.
Stretching Inherited IRA Distributions for Disabled Beneficiaries
The updated Secure Act clarifies that eligible disabled beneficiaries can use their life expectancy rather than the ten-year withdrawal period to determine their RMDs.
The designation of “eligible designated beneficiary” (EDB) applies to disabled individuals (among others), offering families a way to support them with a more extended distribution schedule.
The EDB provisions offer several benefits for disabled individuals, mainly when managing inherited IRA assets. Here are some key advantages:
- Extended Distribution Period: Eligible disabled beneficiaries can use their life expectancy to determine required minimum distributions (RMDs) from inherited IRAs. This allows them to stretch out withdrawals over a longer period, allowing more time for the assets to grow tax-deferred.
- Tax Management: By keeping the withdrawals lower and more manageable, disabled beneficiaries may be less likely to be pushed into higher tax brackets. This helps preserve more inherited assets and minimizes the immediate tax burden.
- Financial Stability: The ability to maintain the tax-deferred status of IRA assets means that these funds can continue to grow without immediate taxation. This can provide a consistent source of financial support throughout the beneficiary’s lifetime, which is especially important given the ongoing needs that may arise due to their disability.
- Protection of Benefits: By carefully managing distributions, disabled beneficiaries can avoid exceeding income thresholds that might jeopardize eligibility for government benefits, such as Social Security Disability Insurance (SSDI) or Medicaid.
- Customized Financial Planning: Families can create tailored financial strategies that accommodate the unique needs of their disabled loved ones. This allows for more thoughtful and supportive financial planning considering long-term care and lifestyle requirements.
Implications for Special Needs Trusts
A special needs trust (SNT) is a common tool for protecting and managing inherited assets for families of disabled loved ones. Secure Act 2.0 reinforces the importance of properly structured trusts, as they provide a means to receive IRA distributions without compromising eligibility for means-tested government benefits, such as Medicaid or Supplemental Security Income (SSI).
A properly drafted SNT allows families to transfer IRA funds into the trust, and the EDB status lets the trust take advantage of the beneficiary’s life expectancy for RMD calculations.
Secure Act 2.0 requires that the trust be structured specifically for the disabled beneficiary. This ensures the trust’s terms align with the IRS’s qualifications for RMD stretch provisions. With this setup, distributions can support the disabled beneficiary while maintaining eligibility for essential government programs.
Important to Obtain Qualified Legal Advice
The trust that the IRA will be left to needs to qualify as a look-through trust so the ongoing IRA distributions can be determined based on the age of the individual who has been determined to be an EDB. The look-through provisions apply to what are considered accumulation trusts which would give the trustee the ability to control distributions. This is important to help protect eligibility for public benefits. The rules as you can see are complex and so it is important to seek qualified tax, legal and financial advice to sort through the issues.
Why Naming a Trust as an IRA Beneficiary Matters
Designating a trust as the IRA beneficiary rather than naming the disabled individual ensures funds are distributed in ways that safeguard eligibility for means-tested benefits. This allows the family to control the pace and purpose of distributions. With Secure Act 2.0, RMDs calculated based on the beneficiary’s life expectancy mean that the trust can be used effectively for long-term planning.
Special needs trusts tailored to Secure Act 2.0’s requirements help avoid pitfalls such as unintentional disqualification from government assistance programs or excessive tax burdens. They also allow families to structure distributions that fit the unique financial and care needs of disabled loved ones.
Tax Considerations for Inherited IRAs and Disabled Beneficiaries
The tax impacts of inherited IRA distributions vary based on the beneficiary’s income and other sources of funds. Disabled beneficiaries or their special needs trusts may be in lower tax brackets, which can reduce the tax burden on required distributions.
The life expectancy distribution method can reduce tax liability by spreading income over a longer period. A stretched RMD schedule can help avoid large, one-time distributions that could push the beneficiary into higher tax brackets, helping the family retain more of the inheritance’s value.
Another important tax-related consideration under Secure Act 2.0 is the potential for Roth conversions, which can minimize taxable income in later years. With a Roth conversion, a traditional IRA is converted into a Roth IRA, allowing for tax-free growth and tax-free qualified withdrawals.
Roth IRAs do not require account holders to take Required Minimum Distributions (RMDs) while they are alive. However, the rules change for the beneficiaries after the account holder passes away. Generally, beneficiaries must begin taking distributions from the inherited Roth IRA, but these distributions can be tax-free if the account has been open for at least five years.
The requirements for RMDs can vary based on the beneficiary's relationship to the deceased and other factors, so consulting with a tax advisor for guidance should be considered.
Roth conversions require careful consideration of timing and tax impacts since any amounts converted in a given year become taxable income. Strategic Roth conversions, possibly done gradually over several years, may limit immediate tax consequences while maximizing future tax-free distributions to the beneficiary or trust.
Final Thoughts
The Secure Act 2.0 significantly benefits disabled persons and those planning for their financial security.
However, its rules and nuances can create potential pitfalls. Thoughtful planning and a clear understanding of the Act’s provisions are essential to maximizing the advantages and avoiding common mistakes.
Working closely with a knowledgeable advisor can further enhance your ability to capitalize on Secure Act 2.0’s opportunities while protecting against unintended consequences.
