SECURE ACT: CHANGES IMPACTING YOUR RETIREMENT ACCOUNT BENEFICIARIES
On December 20, 2019, the SECURE Act was signed into law, triggering potential implications for your estate planning. In particular, the SECURE Act impacts retirement benefits and beneficiary designations in the following significant ways:
1. The Good: RMDs and Contributions. The Act postpones the age at which a plan participant in an IRA or other qualified retirement account must begin taking required minimum distributions (“RMDs”) from age 70½ to the year in which a plan participant turns 72. For those not yet taking RMDs, this change means that you will have a few more years without mandatory distributions. For those already taking RMDs, this change will not impact you. In addition, the Act has repealed the “age cap” on contributions to a traditional IRA so that participants can make tax-deductible IRA contributions without age restriction.
2. The Bad: Elimination of Stretch IRA for Non-Spouse Beneficiaries. Under the prior law, when a non-spouse beneficiary inherited an IRA, the beneficiary had the option of stretching out the RMDs from the IRA, and the corresponding income tax burden, over the beneficiary’s life expectancy. For example, a 50-year old beneficiary inheriting an IRA in 2019 had 34.2 years to stretch out RMDs. Under the new law, the deferral is much more limited. Now, non-spouse beneficiaries will have to withdraw IRA proceeds within just ten years, imposing potentially higher tax brackets and the loss of tax deferral. A few comments about the RMD change:
- Spouses. There is no change in the law for surviving spouses. A surviving spouse still has the ability to roll the deceased spouse’s IRA into his or her own IRA, and treat the IRA as if it is the surviving spouse’s own for purposes of taking out RMDs. A spousal trust will also continue to qualify for a lifetime stretch out so long as appropriately drafted.
- Trusts. A non-spouse beneficiary includes any trust listed as a beneficiary, other than a trust for a surviving spouse or excepted beneficiary listed in (c) below. Under the previous version of the law, if a trust qualified as a “see-through trust,” then the life expectancy of the beneficiary could be used for purposes of stretching out the RMDs. This once favorable strategy no longer works for all trusts. RMDs have to be distributed to the trust within the 10- year time period unless an exception applies. To the extent that the trust retains the distributions from the IRA, those distributions will be treated as ordinary income. Moreover, given a trust’s higher tax brackets, the trust will pay significantly more income tax on that income as compared to an individual beneficiary. In sum, naming a trust as a beneficiary under the new law, particularly as a primary beneficiary, could have unintended, adverse outcomes. You should review all your beneficiary designations, particularly if you named a trust as a beneficiary (often the case for younger beneficiaries or beneficiaries with financial management issues).
- Exceptions to the Ten-Year Payout Rule. There are exceptions to the 10-year payout rule for children who are minors and for disabled or chronically ill beneficiaries. For minor children, the life expectancy payout rules apply until the child reaches the age of majority and then the 10-year rule begins. The life expectancy payout rule applies to a disabled or chronically ill beneficiary (and an accumulation trust for their benefit, which is an important change for special needs beneficiaries). When the disabled or chronically ill beneficiary dies, the remainder of the account passes pursuant to the 10-year rule.
- Timing of Distributions. Under prior law (allowing lifetime stretch out), a beneficiary had to begin taking distributions in the year following the plan participant’s death. Under the new 10-year rule, a beneficiary can defer any and all distributions until the end of the period. Such a deferral would allow for continued tax-deferred growth in the account but must be calculated with care as a larger, later distribution could increase the tax payable (depending on the amount of the distribution and the beneficiary’s tax brackets).
3. Planning Strategies. Naming a surviving spouse the primary beneficiary of a retirement account remains the most favorable income tax option (though other factors, such as a second marriage, could complicate the decision). For contingent beneficiaries, the planning environment has become much more complex. In some instances, conversion to a Roth might be advisable in order to soften the income tax consequences of the new rules. For those who have named trusts as beneficiaries, the trust provisions will need to be altered to avoid unintended consequences and to maximize flexibility for the trustee and the beneficiaries. For those who are charitably inclined, a retirement account could name a Charitable Remainder Trust as a “remainder” beneficiary in order to stretch out distribution for an individual beneficiary longer than the 10-year period (up to the lifetime of that beneficiary), with the understanding that the remainder of the account will be distributed to charity at the individual beneficiary’s death.
We recommend that you review your beneficiary designations and the provisions in your estate planning documents to confirm that your beneficiary designations are up-to-date and still the most appropriate option given the recent changes to the law. If you would like us to assist you with this review, please contact us to schedule an appointment.