The late December 2019 passage of the SECURE ACT (The ACT) by Congress was intended to provide more opportunities for individuals to increase their retirement savings – thus the name: Setting Every Community Up for Retirement Enhancement Act. It's a noble endeavor, but having a profound impact on estate planning.
Reduced IRA Distribution Period
One of the primary provisions of The ACT significantly reduces the IRA distribution period for some beneficiaries, thereby accelerating the collection of taxes and increasing the tax rate itself. Congress estimates this change to generate revenues of $16 billion, which are earmarked to incentivize small businesses to establish new retirement plans. In passing The ACT, Congress has determined that retirement tax provisions should benefit retirement — not the accumulation and passing of tax-favored wealth to heirs.
New 10-Year Termination Date and Elimination of Stretch IRA
The reduced distribution period eliminates the wealth maximization technique known as the “Stretch IRA,” which was used by non-spouse beneficiaries to take required distributions over their remaining life expectancy. A 30-year-old granddaughter, for example, could spread the distributions of her inherited IRA over 50 years, under the old law. Now IRAs inherited by non-spouse beneficiaries in 2020 and after must be distributed during the 10 years after death, such that the account is empty by December 31 in the tenth year.
It is important to note that there are no required annual distributions under the new law, only a “ten-year termination date” to distribute the entire account. Inherited IRAs funded upon deaths prior to 2020 are not impacted.
Since the new law only affects inherited accounts, previous required minimum distribution rules prevail for IRA owners, which are based upon the owner's life expectancy. Likewise, spouses can still rollover accounts. There are also a few other exceptions to the 10-year rule, including beneficiaries who are 10 years younger than the decedent, or those chronically ill, disabled, or minor children.
Reduces Benefits and Use of IRA Trusts
The change to the minimum distribution rules for non-spouse beneficiaries also means the loss of many of the wealth planning benefits of naming a trust, as an IRA beneficiary. An IRA Trust could take advantage of the stretch IRA potential and offered an IRA owner control over distribution of IRA assets after death. These Trusts could preserve the IRA for the benefit of an heir by allowing for growth and providing protection of the IRA account from lawsuits, divorces, and "predators".
Conduit IRA Trusts named as a beneficiary require that IRA distributions, received from the inherited IRA, be paid and taxed to the beneficiary. These trusts will likely be specifically of use to those beneficiaries excepted from the 10-year rule under the ACT ( spouses, minors, etc). Existing conduit trust language for non-funded trusts ( post 2019) should be revisited with estate attorneys, in light of the change made by the ACT. Alternatively, the use of a Discretionary IRA Trust might provide continued control over IRA assets, but with a heavier tax burden. The 10-year payout period of IRA distributions received and retained by a Discretionary IRA Trust are taxed at the Trust tax rates, which are typically higher than an individual’s.
What’s Next: Key Considerations
When a tax law changes, professionals scurry to find remedies, or mitigating strategies. As we learn more about the law, new ideas and additional responses may form. Those impacted by the new provisions will need to reflect upon their estate planning goals, family dynamics, tax brackets, asset breakdown between taxable and tax deferred, etc.
Below are a few items that merit conversation with your advisors. At McKinley Carter, we are addressing the following items with our clients, their estate attorney, and CPA:
- If a Trust is currently designated as a beneficiary of an IRA or 401(k), confirm with your estate attorney that a change should be made in beneficiary designation.
- Control over one’s assets after death is likely eliminated for retirement accounts. Revisit your estate plan and assets through the lens of desire for control.
- Consider the financial impact of preserving taxable assets and spending retirement assets to provide your next generation with trust protections.
- ROTH conversions to pay tax over time, as opposed to your heir’s tax rate? A series of smaller ROTH conversions is a compelling consideration.
- Consider changing 401(k) contributions to ROTH contributions for existing employment.
- Consider the use of Charitable trusts with heirs as annuitants for life.
Depending on your personal financial situation and what stage of life you’re in, there are several other aspects of the SECURE Act worthy of exploring. Consult with your financial advisor and determine what changes, if any, are needed for your financial plan and retirement preparations. In the meantime, here’s a list of articles we highly recommend:
Inheriting IRAs Just Got Complicated, Thanks to New Retirement Overhaul
and for the more technically inclined: