New Retirement Benefit Rules Under the SECURE ActFebruary 21, 2020
What is the SECURE Act?
The Setting Every Community Up for Retirement Enhancement (SECURE) Act was enacted on December 20, 2019 as part of the Further Consolidated Appropriations Act 2020, with most provisions effective January 1, 2020. Qualified Plan participants and IRA owners (collectively referred to as “Participants”) who died prior to January 1, 2020 are subject to pre-SECURE Act rules.
The SECURE Act includes the following positive changes:
- Raises the age to start taking/receiving Required Minimum Distributions (RMDs) for Qualified Plans and IRAs (collectively “Retirement Accounts”) from age 70½ to age 72.
- Allows qualifying individuals to make tax-deductible IRA contributions after age 70½.
However, the SECURE Act also introduces some not-so-positive changes:
- Eliminates payouts based on life expectancy for most non-spousal beneficiaries and replaces them with a new 10-year payout (10-Year Rule).
Required Minimum Distributions at Age 72 and Contributions at Any Age
Under the SECURE Act, individuals may begin taking distributions without tax penalty at age 59½, but will not be required to take the RMD until age 72 (increased from 70½ under pre-SECURE Act rules).
In addition, prior to the SECURE Act, owners of traditional IRAs could make contributions to their IRA until age 70½, with less restrictive rules for Roth IRAs and other defined contribution plans. As of January 1, 2020, there is no longer an age restriction on contributions, and any individual of any age with earned income may contribute to a traditional IRA.
This means that individuals with earned income may make tax-deductible contributions to, and receive distributions from, their IRA in the same year.
Limitations on “Stretch” Inherited IRAs
Under pre-SECURE Act rules, an individual (other than a spouse) inheriting an IRA or defined contribution plan, could elect to take annual distributions from the inherited account over his or her expected lifetime (life-expectancy payments). Particularly in the case of young beneficiaries, the ability to “stretch” distributions over their life expectancy allowed for lengthy tax deferral.
As of January 1, 2020, the SECURE Act eliminates the life-expectancy payout and replaces it with a 10-year payout for all but five specified categories of designated beneficiary (i.e. individual(s) or so-called “see-through” trusts), also known as Eligible Designated Beneficiaries (EDB). The qualification of a beneficiary as an EDB is determined upon the death of the Participant. EDBs not subject to a 10-year payout, and still permitted to receive lifetime-expectancy payments include:
- Surviving spouse of the Participant
- Minor children of the Participant during their minority (upon reaching age of majority, the 10-Year Rule kicks in)
- Chronically ill or disabled individuals
- Individuals not more than 10 years younger than the Participant
Additionally, Retirement Accounts may be stretched over the lifetime of an EDB only once. After the Retirement Account has been stretched over one EDB’s lifetime, the remaining balance must be paid out within 10 years after such beneficiary’s death regardless of whether the successor’s beneficiary would also qualify as an EDB. This 10-year limitation for successor beneficiaries will also apply to pre-SECURE Act beneficiaries receiving life-expectancy payments who die before the payment term has expired.
For those beneficiaries who do not qualify as an EDB, the 10-Year Rule applies, and the account must be fully distributed to the non-EDB beneficiary by December 31st of the year containing the 10th anniversary of the Participant’s date of death. There is no requirement that the beneficiary take distributions in each of those 10 years—rather, distributions of any amount can be made at any time, or times, during the 10-year period, so long as by the end of the period, the account is fully distributed. For many beneficiaries, the 10-Year Rule will have the effect of accelerating income recognition from retirement account distributions and could cause the beneficiary’s income to be taxed at a higher rate than would have been the case had distributions been made over the beneficiary’s lifetime.
If a trust—rather than an individual—is the named beneficiary, the rules are more complex, and you should consult with your attorney or another tax professional to determine what payout options may be available to trustees and beneficiaries. In the event there is no named beneficiary or a non-designated beneficiary (i.e., Participant’s estate, charity, or non-see-through trust), the pre-SECURE Act rules continue to apply.
What Do These Changes Mean for Estate Planning?
Depending on the structure of your overall estate plan, the changes caused by the SECURE Act may have unintended consequences for your plan.
With a life-expectancy payout no longer available for most beneficiaries, the following techniques may be appealing options:
- Qualified Disclaimers. For Participants who died prior to January 1, 2020, and whose accounts have not yet been rolled over to a surviving spouse, a spousal beneficiary may still be able to disclaim his or her interest in a Retirement Account in order to cause the account to pass to an adult child or children. Because pre-SECURE Act rules apply to deaths occurring before January 1, 2020, the adult child would be able to take distributions over his or her expected lifetime, as opposed to 10 years.
- Charitable Remainder Trusts. One possible alternative for non-spousal beneficiaries, particularly if you have charitable inclinations, is to leave the funds to a charitable remainder trust that makes distributions to individual beneficiaries for a fixed term of up to 20 years or the lifetimes of the beneficiaries. Any assets remaining in the trust after the expiration of the term, or the death of the individual beneficiaries, would pass to specified charitable beneficiaries.
- Roth Conversions. Although Roth IRAs are subject to the same 10-year distribution rule as traditional tax-deferred IRAs, converting a traditional IRA to a Roth IRA may be worth considering as a way to address the tax compression and higher marginal tax rates that accelerated payments pose for most beneficiaries under the 10-Year Rule.
- Reconsider Your Current Plan. Review assets and intended beneficiaries to determine if planning objectives will still be accomplished or if there should be a reallocation of assets among such beneficiaries. Some individuals who have been drawing primarily on non-retirement account assets might also determine that better overall tax results will be achieved by drawing more on retirement accounts during lifetime and preserving other assets to leave to their beneficiaries at death.
What Steps Should You Take If You Think the SECURE Act Affects Your Estate Plan?
From an estate planning perspective, the SECURE Act may fundamentally change how your beneficiaries receive your retirement assets. Depending on your situation and objectives, a different approach to estate planning with your retirement benefits may be warranted.
For questions about the SECURE act, or any issues related to your retirement planning or your trust & estate plans, please contact us. We are here to help answer specific questions and offer advice on your options.