With Congress passing the SECURE Act, my Louisiana Estate Planning clients worry how this affects their family’s retirement. Specifically they worry how it will impact their taxes. In short, the SECURE Act creates a climate where individuals who inherit pre-tax retirement accounts will pay more taxes. This is because most individuals inheriting retirement accounts must withdraw and pay tax on all of the inherited retirement within ten years of the IRA owner’s death.
Previously, non-spouse retirement account inheritors could spread out the taxable distributions over their life expectancy. For example, if you inherited a $1,000,000 IRA last year at age 55, you could draw and pay taxes on that $1,000,000 over your life expectancy. The IRS actuarial tables place that life expectancy at roughly 30 years. Without accounting for growth in the value of the account, this equals about $33,000 annually drawn from the inherited account. You add that $33,000 onto your income at year end and pay taxes on those funds at your tax rate.
This new ten year rule has very few exceptions and significantly shrinks the time horizon for taxable IRA distributions. Under the SECURE Act, you would now need to draw down that same $1,000,000.00 within ten years. Electing to take roughly equal distributions annually for ten years increases the yearly distribution from $33,000 to $100,000. Remember, this is before accounting for any growth in the account value. Again, add that $100,000 onto your income at year end and pay taxes on those funds at your tax rate.
Lets explore how this might ultimately increase the amount of tax you pay on the same dollars.
- Adding more income in any given year almost invariably means increasing your marginal tax rate. Your marginal tax rate is the percentage tax you ultimately pay on each dollar you earn.
- Adding $100,000.00 instead of $33,000.00 to your income more likely moves you into a higher income tax bracket. Being in a higher tax bracket clearly increases the amount of tax you ultimately pay on these inherited retirement funds.
- It is likely you will still be working as you draw this larger amount from inherited retirement accounts. In the example scenario where you inherit the IRA at age 55, assume you don’t retire until age 65. These last ten years of your career would in all likelihood be the years where you earn the most income. Adding $1,000,000 over ten years to your already high income could push your taxes to the highest possible rates.
While every situation differs and much depends on timing, there are many reasons to believe the SECURE Act will mean greater taxes for retirement inheritors. While we cannot change the law, we can minimize the impact of these effects with a well designed estate plan. If you worry about the SECURE Act’s impact your heirs, call Legacy Law Center at (504) 274-1980 in Metairie, New Orleans, and surrounding areas or call (985) 246-3020 in Mandeville, Covington, Slidell, Houma, and Thibodaux.