In December 2019, the U.S. Congress enacted into law the “Setting Every Community Up for Retirement Enhancement Act of 2019,” also known as the SECURE Act, as part of a year-end spending bill. The SECURE Act makes major changes to retirement plan rules, including inherited plans. The effective date for the new law is January 1, 2020.
With few exceptions, the SECURE Act radically changed the law surrounding retirement plans in several ways, but the biggest change eliminates “stretch” IRAs for most non-spouse retirement account beneficiaries.
Before the SECURE Act: A designated beneficiary could elect to receive payouts over the beneficiary’s life expectancy, which permitted the beneficiary to defer or “stretch” the receipt of the retirement benefits, resulting in smaller income tax liability on withdrawals and allowing the remaining funds to continue to grow tax free.
After the SECURE Act: The payout rules are substantially changed. With limited exceptions, a designated beneficiary must now withdraw the retirement benefits by the end of the 10th year following the death of the Plan Owner. Moreover, there will no longer be annual required distributions for most beneficiaries. Instead, all the retirement account assets may be withdrawn anytime within the 10-year period.
Many have designated beneficiaries on their retirement accounts with the intention of taking advantage of the “stretch IRA”, which would have allowed the beneficiary(ies) many years to withdraw his or her share of the retirement account. For example, before the SECURE ACT, if Client A died with a 50-year-old son or daughter, that child would have been able to withdraw from the IRA over a 34.2-year life expectancy period. For IRA owners who die on or after January 1, 2020 – when the SECURE Act took effect – the 50-year-old son or daughter will have to withdraw the entire account within 10 years of Client A’s death.
What Type of Plans Does the New Law Affect? With a few limited exceptions, the SECURE Act applies to all qualified retirement accounts, such as IRAs (both traditional and Roth), 401(k)s, 403bs and other similar plans, although some 403b plans may not be affected until 1/1/2022.
To Whom does the New Law Apply? The new law applies to beneficiaries of a Plan Owner who dies on January 1, 2020 and thereafter.
Does the “Stretch” Still work for Some Beneficiaries? Yes. There are several important EXCEPTIONS to the new 10-year rule for designated beneficiaries:
- Surviving spouse – 10-year rule does not apply; a spouse can still roll over the plan benefits and withdraw over that spouse’s life expectancy and designate his or her own beneficiaries.
- Disabled and/or Chronically Ill Beneficiary – 10-year rule does not apply; can use life expectancy payout and this beneficiary does not have to be related to the Plan Owner.
- Minor Child – 10-year rule does not begin until child reaches the age of majority (normally 18). But the minor must be the child of the Plan Owner.
- Beneficiary Less than 10 years younger than Plan Owner – 10-year rule does not apply; can use life expectancy payout. For example, Client A dies and the designated beneficiary of his IRA is his brother, who is 5 years younger. Brother can withdraw over his life expectancy, and if he dies before exhausting the IRA, the IRA benefits that remain are required to be paid over a 10-year period.
ESTATE PLANNING CONSIDERATIONS:
Surviving Spouse: A spouse as a Beneficiary will still have the broad options that existed before the SECURE ACT. Therefore, a spousal rollover may now be the best option. Based upon the value of the retirement assets, it may make sense for the surviving spouse to consider disclaiming at least part of the deceased Plan Owner’s IRA assets if the income tax rates on the payout to the contingent beneficiaries may be less overall (by doing this, you are spreading out the payments of the IRA assets to secure lower income tax rates). In addition, for younger surviving spouses, converting the IRA assets to Roth IRAs may be beneficial. The considerations will include the spouse’s age, health, lifestyle and needs, including other assets available to meet those financial needs.
Disabled/Chronically Ill Beneficiary: If the disabled or chronically ill beneficiary is able to handle his or her own funds and is not on “means-based” government benefits such as Supplemental Security Income (SSI) or Medicaid, that beneficiary may receive his or her benefits outright (i.e., not in trust). However, in most cases, the disabled or chronically ill beneficiary of the retirement account(s) should be a supplemental needs trust, which, if structured properly, will qualify as a “see-through” trust and allow for the payout of the IRA assets over the life expectancy of the beneficiary.
Impact on Trusts as IRA Beneficiaries: One common estate planning strategy is to name a trust as beneficiary of your inherited IRA. These trusts include specific language so that distributions can be stretched over the life expectancy of the trust beneficiary. While there is no change for a current trust beneficiary of an inherited IRA, the impact for a new inherited IRA with a trust beneficiary after December 31, 2019 is not clear. Although there is currently no guidance as to how these trusts will be impacted by the new law, the current view is that these trusts will be subject to the ten-year distribution treatment under the new law. Changing from a lifetime distribution schedule to a ten-year schedule may require rethinking and revising your estate plan, including your trust documents.
Minor Child Beneficiary: While a minor child is exempt from the SECURE ACT if the child’s parents die before the child reached 18. Once the child turns age 18, the 10-year rule applies. If that occurred, the child would have to fully withdraw his or her share outright by age 28, which some parents might still consider too young. As a result, having a “Conduit” Trust as the beneficiary of your retirement account in the place of the child would be preferable because the child will not be able to withdraw from the IRA directly. This type of Trust allows the Trustee to control the withdrawals from the IRA payable to the Conduit Trust until the child turns age 18 and thereafter for the additional 10-year payout. However, it does require that any withdrawals made by the Trustee be paid directly to the child once he or she turns 18.
Alternatively, if parents want the greatest amount of protection over the assets for the child-beneficiary, they may choose an “Accumulation” Trust instead of a “Conduit” Trust. An “Accumulation” Trust allows for the IRA assets paid out to the trust to remain there and to be distributed to the beneficiary at the Trustee’s discretion only (as opposed to a “Conduit” Trust, which moderates the payments of the IRA benefits, but does require that withdrawals from the IRA be paid to the child-beneficiary). However, the “Accumulation” Trust requires a 10-year payout, regardless of the beneficiary’s age (the minor child exception does not apply to Accumulation Trusts). For most young couples with minor children, the “Conduit” Trust will usually make the most sense.
Special Needs Trusts: Special needs trusts are usually drafted as Accumulation Trusts. Unlike conduit trusts, accumulation trusts do not require that the required minimum distributions (RMDs) be distributed. Instead, they can be retained by the trust and distributed as the trustees deem appropriate. Automatically distributing RMDs could undermine eligibility for public benefits the disabled beneficiary may be receiving.
Under the new law, disabled beneficiaries are deemed “eligible designated beneficiaries” and fall under an exception that permits them to continue to stretch withdrawals under the old inherited IRA age-based schedule. But the trust will only qualify for this treatment if the disabled individual is the only beneficiary of the trust during his or her life. If the trust also permits distributions to a spouse or children, it won’t qualify and the IRA will have to be completely withdrawn under the 10-year rule.
One of the problems with the 10-year rule for “Accumulation” Trusts, as opposed to “Conduit” Trusts, is that the withdrawn funds if held by the trust will pay taxes at trust tax rates, which are much higher than individual tax rates in most cases. As a result, if your estate plan includes a special needs trust that could be a beneficiary of your retirement plan assets, it’s important to review the trust with your estate planning attorney.
ADDITIONAL CHANGES UNDER THE SECURE ACT:
Required Minimum Distribution Starting Age Extended: The new legislation defers the Required Minimum Distribution (RMD) starting age from 70 ½ to 72 for individuals with retirement plans. This change only applies to individuals who turn 70 ½ after December 31, 2019.
Traditional IRA Contributions May Continue: Contrary to prior law, individuals who are still working after their RMD age will now be able to contribute to their traditional IRAs. In 2020, the contribution limit for an individual over age 50 is $7,000. The old law permitted contributions past age 70 ½ to Roth IRA and 401K plans and these provisions remain unchanged under the SECURE Act.
Annuities: The SECURE Act removes roadblocks that made employers wary of including annuities in 401(k) plans, making it easier for employers to offer annuities in their retirement savings plan.
Withdrawals: The new law allows an early withdrawal of up to $5,000 from a retirement account without a penalty in the event of the birth of a child or an adoption. Currently, there is a 10 percent penalty for early withdrawals in most circumstances.
The SECURE Act may be accessed here –
(Thanks to my colleague, Matthew J. Nolfo, Esq., who helped prepare the content of this blog post.)
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