Recently, the Setting Every Community Up for Retirement Enhancement Act (SECURE Act) was enacted into law. The SECURE Act makes significant changes to the administration of Individual Retirement Account (“IRA”) and Qualified Retirement Plan (401k, 403b, etc.)(“QRP”), and was effective on January 1, 2020. For many people, an IRA or QRP is one of their most valuable assets. Because these assets result from hard work to create and maintain the account, owners should be aware of the changes found in the SECURE Act and how they may affect the owner’s estate plan.
Amongst other provisions, the SECURE Act:
- Raises the standard age for required minimum distributions (RMDs) for plan participants and traditional IRAs from 70 ½ to 72;
- Repeals the maximum age for contributions to traditional IRAs (Roth IRAs have no contribution age limits); and
- Authorizes penalty free withdrawals of up to $5,000 by each parent in the year of a child’s birth or adoption.
For estate planning purposes, the most significant change in the SECURE ACT is the elimination of the “stretch,” also known as the “life expectancy,” payout option for many beneficiaries. Simply stated, the stretch payout option permits the deceased owner’s account to be slowly distributed over the life expectancy of a designated beneficiary.
A stretch payout option allows beneficiaries to more fully utilize the favorable tax treatment of IRAs and QRPs: investment of the account without contemporary taxation. A stretch payout involved smaller distributions from the account over a longer period of time; minimizing the distributions delayed the income taxes on the assets that were retained in the account, which continued to appreciate on a tax-deferred basis. This increased the rewards of investing both the contributions to the account and the taxable share of the account. The tax-deferral benefit, if properly managed, made IRAs and QRPs potentially more valuable for a designated beneficiary than other forms of inheritance.
The SECURE Act changes these rules for decedents dying after December 31, 2019. Most non-spouse beneficiaries, with some exceptions, must withdraw the entire inherited account within ten (10) years of the owner’s death. The SECURE Act contains exceptions to the general ten-year payout rule, including:
- The account owner’s children who have not attained the “age of majority”;
- Disabled individuals,
- Beneficiaries who are less than ten years younger than the decedent; and
- Chronically ill individuals.
The shorter ten-year payout will likely result in accelerated income taxes on distributions from traditional accounts and reduced benefits from the taxable portion of the account.
From a planning perspective, the SECURE Act may make certain types of trusts more desirable. An accumulation trust authorizes the trustee to retain distributions from an account in trust, and gives the trustee discretion as to when, and how much, of the distributions are applied for the beneficiary. These types of trusts provide increased flexibility to deal with issues relating to creditors, substance abuse/addiction issues, divorce, or other concerns.
In addition to accumulation trusts, other options such as Roth conversions and charitable giving should be evaluated in consultation with a tax advisor. Because of the substantial change in the way distributions these accounts are required, it is important that account owners be aware of the changes contained in the SECURE Act as well as the potential impact on their overall estate plan. If you have any questions concerning this article, please contact Robert Morris at (609)945-7617.
