It has been awhile since made a post, but this development deserves your immediate attention. As you may be aware, the Setting Every Community Up for Retirement Enhancement Act of 2019 commonly being called the SECURE Act was signed into law December 20, 2019 and the changes discussed in this email apply to those who die on or after January 1, 2020. The SECURE Act was passed as part of the bipartisan spending bill with goals of making saving for retirement easier and more affordable, but also to generate funds.
NO MORE STRETCH IRA
The SECURE Act makes a number of changes, but the reason I am writing is to let you know that the SECURE Act impacts estate planning by changing how retirement funds must be withdrawn by the beneficiaries when the account owner dies. These new rules apply to IRAs and employer qualified retirement accounts, such as 401(k) and 403(b) plans. While there are limited exceptions, the SECURE Act eliminates the ability of non-spouse beneficiaries of an IRA or other qualified retirement plan to stretch distributions over their own life expectancies. That is, under the SECURE Act, most beneficiaries will now be required to withdraw all of the inherited retirement account by the end of the 10th year following the account owner’s death. The only exceptions are for the account owner’s surviving spouse, minor child, a disabled or chronically ill individual or a beneficiary who is less than 10 years younger than the decedent account owner. This means that income tax will have to be paid on all of the funds within 10 years of the participant’s death, rather than over the lifetime of the beneficiary. In a simple example, prior to the SECURE Act, if Mom died and named her 50-year-old son as the beneficiary of her $1 million IRA, the son would have been able to take distributions from the $1 million inherited IRA over his 34.2 year life expectancy, thus spreading the income tax over a long period of time and allowing the account to continue to grow tax-deferred. Now, however, the son as beneficiary must withdraw the entire IRA within 10 years of his mother’s death. CONDUIT TRUSTS MAY BE A BIG PROBLEM While the SECURE Act changes will impact all non-spouse beneficiaries, the most severe impact will be on those who have named a trust as a beneficiary of part or all of their retirement account, especially a type of trust that is considered a “Conduit Trusts.” With a Conduit Trust, the trustee was instructed the take the annual required minimum distribution and pay that amount to the trust beneficiary each year. This type of trust often made sense as it allowed the retirement account to be paid out to the trust beneficiary over that beneficiary’s life expectancy. This “Conduit Trust” approach thereby spread the income tax out over a number of years and also limited the beneficiary’s immediate access to a substantial portion of the trust assets since the trustee was only required to pay the beneficiary the modest required minimum distribution (but could pay the beneficiary additional funds in the trustee’s discretion). Now, however, the Conduit Trust will generally have to be paid out to the trust beneficiary within 10 years of the account owner’s death. This will likely increase income taxes and will most likely give the trust beneficiary access to the funds sooner than anticipated.
WHAT TO DO NOW!
These changes impact more clients than any other estate planning development in the past 25 years. If you have a significant IRA or other retirement account or you have named a trust as beneficiary of an IRA, you should review your estate plan in light of these changes.