On December 20, 2019, President Trump signed the Setting Every Community Up for Retirement Enhancement Act (SECURE Act). It is brand-new. It passed immediately without any discussion and was effective on January 1, 2020. The Act is the most impactful legislation affecting retirement accounts in decades. There is good news and bad news.
Overall, the SECURE Act was touted as a law that made it easier for small businesses to provide employees with retirement benefits. When you look up an explanation of the Bill online, that’s what you learn in the headlines: Easier and less expensive for ‘safe-harbor’ retirement plans for both part-time and full-time employees of small businesses. That sounds GREAT, right? And if you’re already retired, it also sounds like it doesn’t apply to you.
But wait, the SECURE Act has several positive changes that impact many people. It increases the required beginning date (RBD) for required minimum distributions (RMDs) from your IRA (which we broadly define to include all tax-deferred retirement accounts) from 70 ½ to 72 years of age. Additionally, it eliminates the age restriction for contributions to qualified retirement accounts.
This means you can hold money in and add money to deferred tax retirement accounts longer. This is good news for retirees who don’t want to tap into their accounts for monthly expenses and spouses hoping to preserve their retirement accounts for spouses who have saved less or will receive lower income when one spouse passes.
However, the bad news, and the most significant change, will affect the beneficiaries of your retirement accounts. The SECURE Act deletes the “Stretch” for most beneficiaries who will now be required to withdraw the entire balance of an inherited retirement account within ten years of the account owner’s death. This change alone warrants a review of every estate plan drafted before January 1, 2020.
Planning for retirement accounts usually ensured that the beneficiaries were entitled to a stretched timeframe for withdrawing funds from the IRA they inherited. The advantage of this was that if you designated your son as beneficiary, for example, upon your death, he could take distributions gradually over his lifetime, and the tax-deferred compounding meant the account was at least twice as valuable to him after tax. We all hope our children will succeed even more than us, meaning at our deaths, their income tax brackets will likely be at a higher level than ours.
With the Stretch, we assured them a lifetime income and did not over-burden their tax consequences when that income was taxed at their rate. They were always REQUIRED to take distributions from your IRA, but they could do so at RMD levels over their lifetime. Under the SECURE Act, retirement accounts passed to certain beneficiaries must be depleted within ten years of the account holder’s death. This means that if you have retirement accounts totaling $1 million, your beneficiary must withdraw all of those funds AND pay tax on them at THEIR tax rate within ten years of your death.
For middle-income taxpayers, this could deplete the value of the inheritance by a third. For many taxpayers, that amount of yearly income (if they choose to take annual distributions) can result in them being bumped into higher tax brackets. The keyword we said is “certain” beneficiaries, meaning there are exceptions. Welcome the new term Eligible Designated Beneficiary.
The number one exception is for a surviving spouse. If you name your spouse as the primary beneficiary of your retirement account, the SECURE Act does change any options available to your spouse. This includes rolling it over, stretching it out, or treating it as an inherited IRA. However, when your spouse passes, that inherited IRA will then be subject to the 10-year withdrawal rules when it passes to the secondary beneficiaries.
The following exception is the account owner’s minor children. It must be your children. Grandchildren and stepchildren are omitted. Minor children are entitled to a limited stretch until they reach the “age of majority.” This could be up to age 26 if they are enrolled in a specified course of education. We will need more guidance from the IRS to know just what that means, but the maximum Stretch could be until age 36 (age 26 plus 10).
The final exceptions are beneficiaries who qualify as disabled beneficiaries, a Chronically Ill individual, and a beneficiary who is not more than ten years younger than the account owner. (It can be someone older they just cannot be more than ten years younger.) This category of beneficiaries can continue to use the Stretch.
Your estate planning goals likely include more than just tax considerations. You might be concerned with protecting a beneficiary’s inheritance from their creditors, future lawsuits, and a divorcing spouse. To protect your hard-earned retirement account and the ones you love, it is critical to act now. Under pre-2020 estate plans where trusts are used to hold inheritances for your beneficiaries, your Plan would have included language that allowed the Stretch to be used by their trusts, thereby maintaining creditor and other asset protections for funds in the inherited IRA. What was fantastic planning last year is now planning that will require the funds to not only be withdrawn from the IRA within ten years but also withdrawn from the Trust.
Proper analysis of your estate planning goals and planning for your intended beneficiaries’ circumstances are imperative to ensure your goals are accomplished and your beneficiaries are properly planned for. Here is your call to action. In light of the SECURE Act, you should review or amend your revocable living trust (RLT).
We may have addressed the distribution of your accounts in your RLT. Your Trust may have included a “conduit” provision, and, under the old law, the trustee would only distribute required minimum distributions (RMDs) to the trust beneficiaries, allowing the continued “stretch” based upon their age and life expectancy.
A conduit trust protected the account balance, and only RMDs–much smaller amounts–were vulnerable to creditors and divorcing spouses. With the SECURE Act’s passage, a conduit trust structure will no longer work because the trustee will be required to distribute the entire account balance to a beneficiary within ten years of your death.
We should discuss the benefits of an “accumulation trust” — an alternative trust structure through which the trustee can take any required distributions and continue to hold them in a protected trust for your beneficiaries.
With the changes to the laws surrounding retirement accounts, now is a great time to review and confirm your retirement account information. Whichever estate planning strategy is appropriate for you, your beneficiary designation must be filled out correctly. If your intention is for the retirement account to go into a trust for a beneficiary, the Trust must be properly named as the primary beneficiary.
If you want the primary beneficiary to be an individual, they must be named. Ensure you have listed contingent beneficiaries as well. Suppose you have recently retired, divorced, married, or been widowed. In that case, you will need to ensure the appropriate changes are made because at your death, in many cases, the plan administrator will distribute the account funds to the beneficiary listed, regardless of your relationship with the beneficiary or what your ultimate wishes might be.
While not a service we can do for you, the SECURE Act increases the pressure we have been putting on clients to talk to their advisors about Roth Conversions. Not only is the drop in the market a perfect time to convert funds from your tax-deferred IRA to a ROTH so that the rebounded gain is now tax-free, but it is also a way to help reduce the tax burden on your beneficiaries.
Although this new law may be changing the way we think about this type of planning, we are here and prepared to help you properly plan for your family and protect your hard-earned retirement accounts. If you are charitably inclined, now may be the perfect time to review your planning and possibly use your retirement account to fulfill these charitable desires.
If you are concerned with the amount of money available to your beneficiaries or the impact on the ultimate amount of the accelerated income tax, we can explore different strategies with your financial and tax advisors. The goal is to infuse your estate with additional cash upon your death.
Give us a call today to schedule an appointment to discuss how the SECURE Act might impact your estate plan and retirement accounts. As always, we offer complimentary reviews of your Plan. For those of you passing this article to friends and family who may not have previously planned with Ross Estate Planning, LLC, we offer complimentary reviews for them as well! Give us a call today!