The SECURE Act: How It Will Affect Your Retirement Accounts and Your Estate Plan
A new law has taken effect that makes significant changes to the rules for making contributions to and withdrawals from retirement accounts. The SECURE Act was signed into law on December 20, 2019, and became effective January 1, 2020.
Individuals with retirement accounts should review the new rules and consider how those affect your retirement plans and your estate plans. A summary of some of the key changes follows.
Key provisions affecting individuals:
Repeal of the maximum age for traditional IRA contributions. Before 2020, traditional IRA contributions were not allowed once the individual attained age 70½. Starting in 2020, you may make contributions to a traditional IRA as long as you have compensation (which generally means earned income from wages or self-employment) regardless of your age.
Required minimum distribution age raised from 70½ to 72. Before 2020, retirement plan participants and IRA owners were generally required to begin taking required minimum distributions, or RMDs, from their plan by April 1 of the year following the year they reached age 70½. Starting in 2020, the age at which you must begin taking distributions from your retirement plan or IRA is increased from 70½ to 72.
Partial elimination of stretch IRAs. The most significant change from an estate planning perspective is the elimination of stretch IRAs for the beneficiaries of inherited retirement accounts. Prior to 2020, beneficiaries of inherited retirement accounts could take distributions over their individual life expectancy, thereby stretching out the tax-deferral advantages of the plan or IRA (referred to as a "stretch IRA").
However, for deaths of plan participants or IRA owners beginning in 2020 (later for some participants in collectively bargained plans and governmental plans), the SECURE Act requires most designated beneficiaries to withdraw the entire balance of an inherited retirement account within ten years of the plan participant or IRA owner’s death.
Exceptions to the 10-year rule are allowed for distributions to (1) the surviving spouse of the plan participant or IRA owner; (2) minor children of the plan participant or IRA owner; (3) a chronically ill individual; and (4) any other individual who is not more than ten years younger than the plan participant or IRA owner. Beneficiaries who qualify under this exception may generally still take their distributions over their life expectancy (as allowed under the rules in effect for deaths occurring before 2020).
Under the SECURE Act, the 10-year time frame may be shorter than that previously available for beneficiaries of inherited IRAs. To the extent the time frame for taking distributions is shorter, it accelerates the income tax on distributions. The larger distributions can bump some beneficiaries into a higher income tax bracket, which reduces the total funds passing to the beneficiaries.
In all cases, analysis of the impact of the new law on your estate planning goals and beneficiaries’ circumstances is imperative to ensure your plan still works.
What should you do now?
Review/Amend Your Trust
If you have named a trust as a designated beneficiary of a retirement account, you may need to amend the terms of your trust. Traditionally, trusts included a “conduit” provision directing the trustee to distribute only the required minimum distributions (RMDs) to the trust beneficiaries, allowing the continued “stretch” based upon their age and life expectancy. A conduit trust passed the RMDs out to the beneficiary to be taxed at the beneficiary’s tax rate (as opposed to the higher trust tax rate), but it protected the account balance from the beneficiary’s creditors, future lawsuits, divorcing spouses and allowed the plan owner to limit the beneficiary’s ability to access and manage the account. With the SECURE Act’s passage, a conduit trust structure would result in the distribution of the entire account within 10 years, which may be a shorter time period than was intended under the estate plan.
A trust may still be a tool to provide continued management and protection of a beneficiary’s inherited retirement account; however, the trust will need to be reviewed to make sure that it will work as intended with the SECURE Act.
Review Intended Beneficiaries
With the changes to the laws surrounding retirement accounts, now is a great time to review and confirm your retirement account information. Whichever estate planning strategy is appropriate for you, it is important that your beneficiary designation is filled out correctly. If your intention is for the retirement account to go into a trust for a beneficiary, the trust must be properly named as the primary beneficiary and the trust must be structured properly. If you want the primary beneficiary to be an individual, he or she must be named. Ensure you have listed contingent beneficiaries as well.
If you have recently divorced or married, you will need to ensure the appropriate changes are made because at your death, in some cases, the plan administrator will distribute the account funds to the beneficiary listed, regardless of your relationship with the beneficiary or what your ultimate wishes might have been.
If you are charitably inclined, now may be the perfect time to review your estate plan and consider using retirement accounts to fund your charitable plans. In some cases, you may be able to obtain a stretch out longer than ten years and obtain similar distributions to your non-charitable beneficiaries by funding a testamentary charitable remainder trust with retirement accounts.
If you are concerned about the amount of money available to your beneficiaries and the impact that the accelerated income tax may have on the ultimate amount, you can explore different strategies with your financial and tax advisors to infuse your estate with additional cash upon your death by using funds from your retirement accounts during your life to purchase additional life insurance and transfer ownership of the policy to an irrevocable life insurance trust (ILIT). The ILIT will help protect the insurance funds from the beneficiary’s creditors and, if desired, can be designed so that the proceeds from the life insurance policy are not includible in the client’s estate.