There’s almost always a reckoning when the government offers a tax break. And so it is with individual retirement accounts (IRA)s, 401(k)s and similar accounts that investors fund with pretax earnings.

The Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019 reset the game board for IRAs and similar accounts (I’ll refer to them collectively as “IRAs” in the rest of this article).

Investors, you’ll remember, pay ordinary income tax on withdrawals from IRAs—whether they are voluntary or required minimum distributions (they don’t on Roth IRAs, of course, but we’ll get to those later). When people have stopped working, they often pay lower income tax rates. Life is good.

The SECURE Act, however, changed the guidelines for the payout of IRAs and similar accounts if an account owner dies with assets in the accounts. Beneficiaries who are not spouses of the account owners now have 10 years to empty the accounts—setting them up for potentially large tax bills, maybe in years when their ordinary income tax rates peak.

Altogether, the situation puts the onus on financial advisors to inform their clients and help them plan for future scenarios in which they and their families may find themselves.

Inherited IRAs And Beneficiaries: Scenarios And Options
Investors or couples with significant IRAs and brokerage assets are the most likely to face the consequences of the new tax regulations for RMDs and inheritance from the SECURE Act.

A widowed spouse inheriting a partner’s IRA faces the lower of two figures: either the spouse’s RMD rate or the partner’s RMD rate (which are tied to birth years). More significantly, though, a widowed spouse is a single return filer, not a joint filer—which halves available deductions and tax brackets.

The lesson is: Whether single or married, clients should consider accelerating IRA withdrawals when their taxable income wanes early in retirement. Tapping IRAs voluntarily in those years can also mean they defer their Social Security benefits to age 70, which optimizes them.

Non-spouse beneficiaries of inherited IRAs—often adult children—have 10 years to empty those accounts. The beneficiaries’ tax rates will depend on how much they earn, whether they file single or joint returns, and the deductions available. If a beneficiary dies while the account still has assets, those assets could be subject to estate taxes (at very high rates).

The lesson is: Estate planning is essential in this scenario. IRA owners may want to “equalize” inheritances among heirs in ways other than dividing assets evenly. For example, investors may want to make a child with lower taxable income the beneficiary of the IRA and give another child with higher earned income the assets of brokerage accounts or Roth IRAs. Or IRA owners may want to establish trusts or make charitable bequests to empty IRAs before they can become part of an estate.

How To Best Help Your Clients 
Start by asking clients with excess IRA assets about where they want their money to go—or what they want it to fund—after they die. Trust me: They think about this. But many fail to plan—and regret it later.

If clients want the account assets to go to the beneficiaries they selected, analyze the situation carefully, using a tax calculator designed to include estimates of taxable income, filing status and residency.

You’ll need to match the estimated year of inheritance with each adult child’s age and earnings trajectory. You can then compare the beneficiaries’ average tax rates and recommended IRA withdrawals that empty the traditional IRAs in the most tax-efficient manner.

Another strategy for helping clients who don’t expect to exhaust their IRAs in their lifetimes is to systematically and thoughtfully withdraw money early in retirement and fund Roth conversions. Inherited Roth IRAs need to be drawn down in 10 years, but the money isn’t taxable to beneficiaries.

Decumulation planning—which covers part of what I’ve described—is complex but, thanks to technology, entirely within your capabilities. Use it to create the optimal income sourcing plan for each client based on all their assets—taxable and tax-advantaged accounts, Social Security benefits, brokerage accounts, real estate and other property, pensions, life insurance and annuities.

Clients may indeed worry more about outliving their assets than about their assets outlasting them. But the government has a valid interest in not letting assets with favorable tax treatment languish in accounts. Your clients do, too.

Paul R. Samuelson is the chief investment officer and co-founder of LifeYield.