The ‘Setting Every Community Up for Retirement Enhancement’ Act (the “SECURE Act”) was signed into law on December 20, 2019 and became effective January 1, 2020. The new law contains a number of provisions affecting qualified retirement plans, including 401(k)s, annuities, IRAs, as well as the federal income tax consequences of these qualified retirement plans that may affect your estate plan. This piece discusses several of the major provisions of the SECURE Act that should encourage you to review your existing estate plan and beneficiary designations.
Contribution Age Increased for Traditional IRAs
Under previous law, a traditional IRA participant could not make contributions to the IRA after age 70 ½. The SECURE Act now allows traditional IRA participants to contribute to an IRA regardless of age. As before, contributions to a Roth IRA are allowed regardless of age, as long as the participant has earned income.
Qualified Charitable Distributions
The SECURE Act did not change the age at which qualified charitable distributions may be made, that age remains 70 ½. However, the amount that will qualify as a qualified charitable distribution will be reduced by any contribution made by the participant after age 70 ½.
New RMD Rules
The SECURE Act changes the age of initiation for Required Minimum Distributions (“RMDs”) from 70 ½ to 72. The RMD is the minimum amount owners and qualified plan participants must withdraw from a qualified retirement account each year in order to avoid a penalty. This change will allow additional time for IRAs to grow tax-deferred. However, it is important to note that for participants turning 70 ½ in 2019, the first RMD must still be taken by April 1, 2020. By contrast, participants who did not turn 70 ½ by December 31, 2019, do not have to begin taking RMDs until April 1 of the year after they reach 72. The new RMD rules do not apply to Roth IRAs; there are no RMDs for Roth IRAs while the plan participant is living.
Elimination of the “Stretch” IRA
In most instances the SECURE Act mandates inherited IRAs with non-spouse beneficiaries (children or grandchildren) must be fully withdrawn within 10 years of the participant’s death. Under prior law, an IRA beneficiary could take RMDs over the beneficiary’s own life expectancy. For example, a 50-year old beneficiary could have spread RMDs over 34.2 years, and a 25-year old beneficiary could have spread RMDs over 58.2 years. The ability to defer distributions allowed for an extended period of tax-deferred growth of the plan. The “stretch” is now gone. Except in cases of “eligible designated beneficiaries,” which includes spouses, minor beneficiaries, chronically ill beneficiaries, beneficiaries with special needs, or a beneficiary within 10 years of age of the IRA owner, the balance of an inherited IRA must be fully distributed within 10 years of the participant’s death. Distributions may be taken at any time during the 10-year period, with no annual requirement, as long as the account is fully distributed by the end of the 10th year.
Impact of the 10-Year Rule on Trusts Designed to Receive IRA Assets
With the elimination of the stretch IRA, trusts may become problematic beneficiaries of retirement plan assets. Under prior law, the “stretch” could also apply for a trust, if the trustee was required to withdraw and distribute the RMD to the trust beneficiary each year. This type of trust is commonly referred to as a ‘conduit trust.’ This allowed the IRA to remain under the control and protection of the trustee over the beneficiary’s lifetime. Under the SECURE Act, even a conduit trust must distribute the entire IRA to the beneficiary within 10 years of the owner’s death. This may conflict with the goal of protecting assets for the beneficiary’s lifetime by using a trust such as for creditor protection, protection from marital disharmony, and transfer tax savings.
In light of this change to the conduit trust framework, an ‘accumulation trust’ may be considered. An ‘accumulation trust’ would still require the entire balance of the retirement plan to be distributed to the trust within 10 years and income taxes would be payable by the trust at higher tax rates than may apply for the trust beneficiary. However, an accumulation trust would allow the assets to remain in trust and give the trustee discretion to make distributions to the beneficiary beyond the 10-year period.
This piece is not intended to cover all the estate planning issues created by the SECURE Act. Individuals with significant qualified retirement plan assets should speak with their estate planning attorneys to understand how the SECURE Act affects their estate plan and beneficiary designations and to discuss any necessary changes.