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.
Indeed, the changes ushered in by the SECURE Act have dramatic implications for both your retirement and estate planning strategies — and not all of them are positive. While the law includes some taxpayer-friendly measures to boost your ability to save for retirement, it also contains provisions that could have disastrous effects on planning strategies families have used for years to protect and pass on assets held in retirement accounts.
Given this, if you hold assets in a retirement account, you need to review your financial plan and estate plan as soon as possible. To help you with this process, here we’ll cover three of the SECURE Act’s most significant changes and how they stand to affect your retirement account both during your lifetime and after your death. Next week, we’ll look more deeply into a couple of additional strategies you may want to consider.
1. Increased age for Required Minimum Distributions (RMD)
Before the SECURE Act, the law required you to start making withdrawals from your retirement account at age 70 ½. But 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.
2. 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 or your spouse are still working.
These two changes are positive because with our increased life spans, people are now staying in the workforce longer than ever before, and 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’ll see below, the SECURE Act also includes some less-favorable changes to the distribution requirements for retirement accounts after your death.
3. Elimination of stretch provisions for inherited retirement accounts
The part of the SECURE Act that’s likely to have the most significant impact on your heirs is a provision that makes substantial 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 expectancies. 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, paying income tax on just a small amount of their inheritance every year. And in that case, the income tax law would encourage the child not to withdraw and spend the inherited assets all at once.
Under the SECURE Act, however, most designated beneficiaries will now be required to withdraw all the assets from the inherited account — and pay income taxes on them — within ten years of the account owner’s death. Those who fail to withdraw funds within the ten-year window face a 50% tax penalty on the assets remaining in the account.
The law does offer exemptions to the mandatory ten-year withdrawal rule for beneficiaries known as eligible designated beneficiaries (EDB):
1. 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.
2. Beneficiaries who are less than ten years younger than the account owner may still take distributions based on their own life expectancy.
3. Your minor children, who have not reached the “age of majority” don’t have to deplete the account until ten years after they come of age. Yet that still would be a much shorter “stretch” than previously available.
4. 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 are no longer available. If you want the people who will inherit your retirement account to benefit from long-term income tax deferral — as well as asset protection from lawsuits, creditors, or divorce — you should meet with us now to rework your plan.
Impact on trusts: 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, revocable trust, or standalone retirement trust. Before 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.
This allowed the beneficiary to take advantage of the continued “stretch” based on their age and life expectancy. In this way, the conduit trust protected the account balance and only exposed the much smaller RMD amounts to creditors and divorcing spouses.
Under the SECURE Act, however, the ten-year limit for taking distributions will lead to the acceleration of income tax due, possibly bumping your beneficiaries into a higher income tax bracket. This potentially hefty tax burden would likely result in your beneficiary receiving significantly less from the retirement account than you had initially planned on.
What’s more, because the SECURE Act requires all funds in your retirement account to be withdrawn within ten 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: Given the SECURE Act’s new rules, you may want to consider amending your trust to shift it from a “conduit trust” to become an “accumulation trust.” Such a trust structure can’t extend the tax benefits any longer than ten years, but it can protect the assets from your beneficiary’s future risky activities or a divorce.
One important thing to note: Retained distributions from a traditional IRA distributing 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 an 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. We’ll share some options for this in next week’s article.
Update your estate plan now
As experienced Legacy Estate and Planning attorneys, we can update your plan to address the potential ramifications the SECURE Act might have on the distribution of your retirement assets to your loved ones following your death. But to do that, we need to meet with you to consider your family dynamic and all of your assets, so we can thoroughly assess the big-picture impact the SECURE Act stands to have on your estate.
This is precisely what we do during our Family Wealth Planning Session, a two-hour working meeting that educates and empowers you to know you’ve done the right thing for the people you love no matter what happens to you. Whether you’ve yet to create a plan or already have one created by another lawyer, schedule an appointment today.
Next week in the second part of this series, we’ll cover some of the potential ramifications the SECURE Act stands to have on your financial-planning strategies and how you can make the most of the new legal landscape.
This article is a service of Ruberg Law, PLLC. We don’t just draft documents; we ensure you make informed, empowered decisions about life and death, for yourself and the people you love. That’s why we offer a Family Wealth Planning Session™. During the session, you will get more financially organized than you’ve ever been before and make all the best choices for the people you love. You can begin by calling our office today to schedule a Family Wealth Planning Session™ and mention this article to find out how to get this valuable session at no charge.