On January 1, 2020, the Setting Every Community Up for Retirement Enhancement Act (SECURE Act) went into effect, and it represents the most significant retirement-planning legislation in decades. The changes ushered in by the SECURE Act may have dramatic implications on your retirement and estate planning strategies. If you like to read, check out the exact language of the new law here. Not all of those changes are positive.
If you hold assets in a retirement account, you need to review your financial and estate plan now!
The new law does include a number of taxpayer-friendly measures to boost your ability to save for retirement. However, the new law also contains provisions that could have disastrous effects on strategies that families have used for years to protect and pass on assets contained in retirement accounts.
Changes after implementation of the SECURE Act
To help you with this process, I will explain how the new law may affect your retirement account during your lifetime and after your death.
Increased age for Required Minimum Distributions (RMD)
Prior to the SECURE Act, the law required you to start making withdrawals from your retirement account at age 70 ½. For people who haven’t reached 70 ½ by the end of 2019, the SECURE Act pushes back the RMD start date until age 72.
Repeal of the maximum age for IRA contributions
Under previous law, those who continued working could not contribute to a traditional IRA once they reached 70 ½. Starting in 2020, the SECURE Act removed that cap, so you can continue making contributions to your IRA for as long as you and/or your spouse are still working. These two changes are positive. With our increased life spans, people are now staying in the workforce longer than ever before. The new rules allow you to continue contributing to your retirement accounts and accumulating tax-free growth for as long as possible.
However, to offset the tax revenue lost due to these beneficial changes – as you will see below – the SECURE Act also includes some less-favorable changes to the distribution requirements for retirement accounts after your death.
Elimination of stretch provisions for inherited retirement accounts
The part of the SECURE Act that is likely to have the most significant impact on your heirs is a provision that makes significant changes to distribution requirements for inherited retirement accounts, and effectively ends the so-called “stretch IRA.” Under prior law, beneficiaries of your retirement account could choose to stretch out distributions—and, therefore, the income taxes owed on those distributions—over their own life expectancy.
For example, an 18-year old beneficiary expected to live an additional 65 years could inherit an IRA and stretch out the distributions for 65 years. That beneficiary would pay income tax on just a small amount of their inheritance every year. In that case, the income tax law would encourage the child to not withdraw and spend the inherited assets all at once.
Under the SECURE Act, most designated beneficiaries will now be required to withdraw all the assets from the inherited account—and pay income taxes on them—within 10 years of the account owner’s death. Those who fail to withdraw funds within the 10-year window face a 50% tax penalty on the assets remaining in the account.
Exemptions to the new law
The law does offer exemptions to the mandatory 10-year withdrawal rule for certain beneficiaries, known as “eligible designated beneficiaries” (EDB):
- A surviving spouse named as an outright beneficiary of a retirement plan still has the option of rolling over the benefits to his or her own IRA or taking distributions based on his or her own life expectancy.
- Beneficiaries who are less than 10 years younger than you can still take distributions based on their own life expectancy.
- Your minor children, who have not reached the “age of majority” don’t have to deplete the account until 10 years after they come of age. Yet that still would be a much shorter “stretch” than previously available.
- Disabled individuals and chronically ill individuals can take distributions based on their life expectancy.
Apart from these exceptions, opportunities for stretching an IRA over an extended period of time are no longer available. If you want your retirement account beneficiaries to benefit from long-term income tax deferral, and asset protection from lawsuits, creditors, or divorce, you must meet with me now to rework your plan.
The SECURE Act may impact previous estate planning strategies
Depending on the value of your retirement account, you may have already addressed the distribution of its assets using a “conduit” provision in your will or trust. Prior to the SECURE Act, a trustee of a trust that included a conduit provision would only distribute the required minimum distributions (RMD) to trust beneficiaries each year.
Using a conduit trust allowed the beneficiary to take advantage of the “stretch” based on their age and life expectancy. In this way, the conduit trust protected the account balance and exposed only the much smaller RMD amounts to creditors and divorcing spouses. Under the SECURE Act, the 10-year limit for taking distributions will lead to the acceleration of income tax due. That acceleration of income tax due may bump your beneficiaries into a higher income tax bracket. This potentially hefty tax burden would likely result in your beneficiary receiving significantly less funds from the retirement account than you originally planned.
Moreover, because the SECURE Act requires all funds in your retirement account to be withdrawn within 10 years after your death, a conduit trust would be required to distribute all of its assets outright to the beneficiary within this shortened period. This means you would also lose any long-term asset protection you may have built into your plan.
Alternative options moving forward
Given the SECURE Act’s new rules, you may want to consider amending your trust to shift it from a “conduit trust” to an “accumulation trust.” An accumulation trust structure cannot extend the tax benefits any longer than 10 years, but it can ensure the assets are protected from your beneficiary’s future risky activities and/or a divorce.
One important thing to note: Retained distributions from a traditional IRA to an accumulation trust would be exposed to compressed income tax rates that apply to trusts. Currently, trusts reach the maximum 37% tax bracket with undistributed taxable income of $12,950. Facing such a tax hit, if you opt for this solution, your plan should include additional strategies to address the tax obligation. I will share some options for this strategy in next week’s article.
Update your estate plan now
As your Personal Family Lawyer®, I can update your plan to address all of the potential ramifications the SECURE Act might have on the distribution of your retirement account’s assets following your death. To accomplish this, we need to meet to consider your family dynamic and all of your assets. This way, we can thoroughly assess the big-picture impact that the SECURE Act stands to have on your estate.
Contact me today to discuss your estate planning options in light of the implementation of the SECURE Act. Next week in the second part of this series, I will cover some of the ramifications the SECURE Act may have on your financial-planning strategies and how you can make the most of the new legal landscape.