The SECURE Act Part 2: Retirement Account Estate Planning Changes
As reported in our January 9, 2020 Client Alert “The SECURE Act Passes: The Future is Now” President Trump signed into law landmark legislation titled the “Setting Every Community Up for Retirement Enhancement” Act (SECURE). Most provisions of SECURE impact tax-deferred retirement plans such as IRAs, 401(k), and 403(b) plans. Our previous client alert outlined the general tax rules brought about by SECURE, which are significant changes from prior law. While some of the changes can be helpful to employers and plan administrators, some detrimentally impact estate planning and income tax deferral techniques that participants have relied upon for decades. Below is a summary of the key provisions of SECURE that are relevant to this planning. If you have retirement plan accounts, we recommend you contact your estate planning attorney to review current beneficiary designations and their coordination with your wills, revocable trust provisions, and overall estate plan.
Effective Date of SECURE. Even though the legislation was signed into law on December 20, 2019, it only applies to plans of participants or owners who died after December 31, 2019.
Required Beginning Date (RBD) Age Change. A significant change to the old rules is that required minimum distributions (RMD) must now be taken at age 72, instead of 70½. Note that given the effective date of SECURE, a person who reached age 70½ by December 31, 2019, will remain subject to the old rules and therefore must begin taking RMDs by April 1, 2020. Consistent with the prior law, Roth IRAs are not subject to the RMD rules until the Roth IRA owner (or the spouse of the deceased owner who rolled over into his or her own Roth IRA) dies.
Repeal of Maximum Contribution Age. Previously, IRA contributions had to stop when an IRA owner reached age 70½. SECURE eliminates the maximum age for contributions to traditional IRAs and allows owners who continue to work into and beyond their 70s to be able to continue making tax-deferred contributions of earned income to their IRAs.
Ten-Year Rule and Elimination of Stretch IRA. SECURE makes drastic changes to the tax-deferral available after the death of the account owner and spouse. The rules for a surviving spouse named as beneficiary are unchanged. But for non-spouse beneficiaries, SECURE effectively eliminates the “Stretch IRA” which allowed an individual beneficiary to defer income tax recognition by taking withdrawals over the individual’s life expectancy. Instead, SECURE requires most non-spouse beneficiaries to withdraw the retirement plan or IRA proceeds, and pay the deferred income tax, within ten years after the death of the account owner.
- Planning Takeaway. When the ten-year rule applies, the beneficiary may withdraw retirement plan benefits at any time during the ten years after the plan participant’s death as long as all the funds are withdrawn by the end of the ten-year period. So the beneficiary could choose to take a portion each year, periodically, or could bunch distributions until the last year.
- Planning Takeaway. The ten-year rule may upset an estate plan that has utilized a trust applying “conduit trust” provisions (trusts that act as “conduits” to hold retirement accounts and control distributions to beneficiaries). If your estate plan incorporates a conduit trust to govern retirement plan accounts, you should review your plan with your estate planning attorney as soon as possible. Your attorney may recommend a trust that accumulates retirement plan distributions for the beneficiary to avoid a large lump sum distribution to the non-spouse beneficiary after ten years. Similarly, the ten-year rule will frustrate estate plans where retirement plans were earmarked, either outright or in trust, for grandchildren or other younger generation beneficiaries.
- Planning Takeaway. Participants or owners who have philanthropic intent should consider (even more so than before) naming charitable beneficiaries as beneficiaries of their retirement plans. These could be specific charities, a donor advised fund, or a private foundation, where income tax can be generally eliminated on the payout given the charitable status of the beneficiary. More sophisticated planning techniques involving the coordination of a retirement plan with a certain type of charitable trust known as a Charitable Remainder Trust (CRT) can also be advantageous.
Exception Beneficiaries. There are limited exceptions to the ten-year rule that apply to non-spouse beneficiaries. These include beneficiaries who are minor children, disabled or chronically ill, or are less than ten years younger than the deceased account holder. However, each of these exceptions is riddled with nuanced definitions and enabling requirements that are beyond the scope of this alert.
- Planning Takeaway. The exceptions to the ten-year rule are complex and must satisfy strict definitional requirements, some of which are still unclear under the new rules. It is important to seek guidance from your estate planning attorney and tax advisor on these definitions to properly assess whether stretch IRA planning remains available for these individuals in a participant’s or owner’s estate planning.
Taking the Insecurity Out of SECURE. If you are a participant in or owner of a retirement plan account, you are subject to SECURE. However, the impact to your income and estate planning will depend on your tax and non-tax related goals. Retirement account planning has traditionally focused on achieving the longest possible payout period to allow for tax income tax deferral. And the tax deferral could co-exist with creditor protection planning for beneficiaries through the use of a properly drafted trust agreement. SECURE has eliminated the former type of planning in most instances. However, with a new set of rules lies new planning opportunities to potentially mitigate the impact of the ten-year payout while still achieving creditor protection. As noted earlier, if you have retirement plan accounts, we recommend you contact your estate planning attorney to review current beneficiary designations and their coordination with your wills and revocable trust provisions, to ensure your overall estate plan functions as intended.