February 12, 2020
The Setting Every Community Up for Retirement Enhancement Act (the "SECURE Act") was passed as part of a 2019 year end federal appropriations bill and became effective January 1, 2020. The SECURE Act makes significant changes to how qualified retirement plans may be distributed to beneficiaries after death and will have a major impact on estate planning. Given the significance of the changes enacted by this legislation, any client with significant assets in a qualified plan or IRA is urged to immediately contact our attorneys to review his or her estate plan to ensure that it disposes of these assets in the most advantageous manner, taking into account the SECURE Act changes.
The SECURE Act contains three major changes to current IRA law that take effect immediately. The first change that the SECURE Act makes is to move the age at which a person must begin taking distributions from a qualified plan or IRA ("Required Minimum Distributions" or "RMDs") from age 70 ½ to age 72 (applicable to those who were not yet required to take distributions under the old law). This is considered a pro-taxpayer change, as it permits taxpayers to retain assets in the qualified plan or IRA for a longer period of time before they are required to begin taking taxable distributions.
The second change that the SECURE Act makes is to eliminate the 70 ½ age limit for contributing to a traditional (non-ROTH) IRA. Under the law prior to the SECURE Act, an individual could not make contributions to a traditional IRA for any tax year after they reach 70 ½. The SECURE Act allows an individual earning wages or income from self-employment to continue making contributions to a traditional IRA with no age limitations, permitting significant tax deferral for those eligible to make such contributions. It also lengthens the period to utilize a backdoor Roth IRA whereby a taxpayer, whose income is too high to qualify for a Roth IRA contribution, may contribute to a regular IRA and then convert the regular IRA to a Roth IRA.
The third and most significant change that the SECURE Act makes is to require that most designated beneficiaries receive the full amount of an inherited qualified plan or IRA within 10 years of the death of the person who funded the plan or IRA.
Under the old law, it was possible to stretch the distribution of inherited qualified plan or IRA assets over the life expectancy of a beneficiary, if that beneficiary met the requirements of a "designated beneficiary" under the law. This lifetime stretch-out offered advantages in terms of income tax free growth of the retirement assets during the beneficiary's life and protection of the retirement assets from the beneficiary's creditors or from a beneficiary who might not have the ability to handle significant amounts of money at one time. The law also permitted these advantages for retirement assets left in trust, as long as the trust was structured to meet certain requirements. It should be noted, however, that accounts inherited before January 1, 2020 continue to be governed by prior law except that if the current beneficiary dies before the account is completely withdrawn, the successor beneficiary must withdraw the balance within ten (10) years.
Under the Secure Act, there are exceptions for surviving spouses, as well as beneficiaries who are disabled or chronically ill, individuals less than 10 years younger than the deceased IRA holder, and minor children of the deceased IRA holder (but not grandchildren or step-children). As regards minor children, the 10 year maximum period will begin to run once a minor child has attained the age of majority (which period can be extended while the beneficiary is a student). Interestingly, under the new 10 year rule of the SECURE Act, no annual withdrawals need to be made during the 10 year period, but the entire IRA must be distributed by the end of the tenth year following the year the account holder dies.
This significant change has the potential to cause serious disruption for those who have incorporated “stretch” IRAs into their estate planning.
Taxpayers may want to consider certain planning strategies such as Roth IRA conversions. Given the current income tax rates, it might be advisable to convert a traditional IRA to a Roth IRA, pay income tax currently and have future generations inherit the Roth IRA (income tax free) rather than the traditional IRA. Taxpayers should consult their tax advisors prior to undertaking this decision.
Accumulation trusts should also be considered to offset the negative impact of the SECURE Act. An accumulation trust is a trust that gives the trustee the power to decide how and when to make distributions to beneficiaries based on certain guidance of the testator (under a will) or grantor (under a trust), but does not require the trustee to make the distributions at a set time or in fixed amounts. An accumulation trust could be used to spread the bequests from inherited IRAs between multiple generations of children, grandchildren and great-grandchildren. More importantly, although the accumulation trust must withdraw the entire retirement account by the tenth (10th) year, the trustee can continue to retain the corpus in a discretionary trust.
Unlike accumulation trusts, a conduit trust must distribute all required distributions from a retirement plan to the individual beneficiary. Since the SECURE Act generally requires that IRA distributions take place over a 10 year period, all of the IRA benefits in a conduit trust will be distributed to a beneficiary over a maximum time period of 10 years, whereas an accumulation trust will provide for longer protection (from creditors, divorce or the like) of the distribution proceeds since the funds from the IRA can, at the trustee's discretion, remain in the trust indefinitely (after they have been withdrawn from the IRA). Clients who have provided for conduit trusts as beneficiaries of their retirement plans may want to consider using accumulation trusts instead.
Finally, Charitable Remainder Trusts ("CRTs") should be considered for a client who has some charitable intent and a desire to leave a lifetime income stream to a beneficiary instead of a 10-year payout taxed at potentially high rates. Traditional retirement benefits can be paid income tax-free into the CRT, which then pays a lifetime stream of fixed dollar or fixed percentage payouts (taxable) to the individual beneficiary. Life insurance can be utilized to replace the amount going to charity at the beneficiary’s death.
In short, the SECURE Act provides for major and significant changes to the IRA rules. The SECURE Act not only affects a taxpayer's ability to contribute to an IRA and the timing of the taxpayer's RMDs, but also has a dramatic effect on the client's estate planning.
In particular, clients who have designated a trust as a beneficiary of a retirement account must review their plan to determine what revisions are necessitated by the new law to ensure the longest possible distribution period and preserve the protection of the retirement account.
Clients are urged to consult with one of our attorneys as soon as possible in order to ensure that their current estate planning documents and beneficiary designations meet their objectives.