On December 20, 2019, President Trump signed into law the Setting Every Community Up for Retirement Enhancement Act (SECURE Act). The SECURE Act substantially changes the law applicable to IRAs and other retirement vehicles. As a result, the new law may have a significant impact on your current estate plan. This article summarizes some of the changes to the law resulting from the SECURE Act. We strongly recommend that you review your IRA and retirement account beneficiary designations and consult with counsel to determine whether changes to your current beneficiary designations or estate planning documents are necessary or advisable.
Partial Elimination of Inherited Retirement Account 'Stretch' Provisions
Before January 1, 2020, all beneficiaries of an IRA or other retirement account were able to defer income taxes on an inherited retirement account by “stretching” out distributions from the inherited retirement account over the beneficiary’s life expectancy. This stretching technique permitted a beneficiary to withdraw the minimum amount each year from the account, while allowing the inherited retirement account to continue to grow tax deferred for the rest of the beneficiary’s lifetime. For deaths of plan participants or IRA owners after December 31, 2019, the SECURE Act eliminates the option to stretch distributions over the beneficiary’s life expectancy for most beneficiaries other than a spouse, and forces the liquidation of an inherited IRA or other retirement account within 10 years following the death of the plan participant or IRA owner (10 Year Rule).
Spouses are not subject to the 10 Year Rule. While there are other exceptions to the application of the 10 Year Rule,1 the inability of a nonspouse beneficiary to stretch distributions over his or her life expectancy makes it advisable for owners of retirement accounts to review and potentially revise their beneficiary designations and their estate planning documents to ensure that the requirements of the new law are consistent with their estate plans.
The 10 Year Rule also has an impact on the use of trusts as beneficiaries of retirement plans. Under the prior law, a trust holding an inherited IRA or retirement account could be designed to utilize the stretch over the life expectancy of a beneficiary of the trust. These trusts were required to be structured as either “Conduit Trusts” or “Accumulation Trusts.” A Conduit Trust is structured to require that all amounts received from an inherited IRA must immediately be distributed to the trust beneficiaries such that the trust is a mere “conduit” for the beneficiary. An Accumulation Trust is structured to allow the distributions from the inherited IRA to “accumulate” inside of the trust, and those distributions need not be distributed from the trust. Unlike a Conduit Trust, where the stretch is based on the life expectancy of the conduit beneficiary, in an Accumulation Trust, the stretch is based on the life expectancy of the oldest beneficiary of the trust, including any beneficiary who may have an interest in the trust upon the death of a current beneficiary. Thus, Conduit Trusts were often used in an estate plan to ensure that the stretch out period would be based on the life expectancy of the current trust beneficiary and not of an older contingent beneficiary with a shorter life expectancy.
With the new 10 Year Rule, Conduit Trusts may result in required distributions from the trust that are contrary to the intentions of the retirement account owner. Because the retirement account benefits will be forced out over a period of not more than 10 years following the account owner’s death, a Conduit Trust may cause all of the retirement assets to be distributed outright to the beneficiary sooner than the retirement account owner had planned and in larger amounts than previously assumed.
Accumulation Trusts also will be subject to the 10 Year Rule as a result of the SECURE Act. Therefore, the trust-owned inherited retirement benefit has many fewer years of tax-deferred growth, and the trust could recognize all or a substantial portion of the income tax attributable to the inherited IRA or other retirement account at the income tax rates applicable to trusts, which generally will result in more income taxes being paid than if the benefits were to be taxed to the individuals. Therefore, an Accumulation Trust plan could result in more income tax than was anticipated when the decision was made to utilize an Accumulation Trust in the estate plan.
Contributions to Traditional IRAs Now Permitted Beyond Age 70.5
Contributions to traditional IRAs have been prohibited after the IRA owner reaches age 70.5. The SECURE Act eliminates the age restriction and provides that, beginning in 2020, individuals of any age may contribute to a traditional IRA, so long as the individual earns compensation in that year. Compensation generally includes income earned from wages or self-employment.
Required Minimum Distributions (RMDs) Begin at Age 72
IRA owners and other retirement plan participants generally have been required to begin taking RMDs by April 1 of the year following the year in which they reach age 70.5. With the SECURE Act, individuals who reach age 70.5 after December 31, 2019 may now delay taking their RMDs until April 1 of the year following the year in which they reach age 72. For those IRA owners or plan participants who reached age 70.5 on or before December 31, 2019, they must take or continue to take their RMDs even if they have not yet reached age 72.
In light of the above developments, we urge you to review your estate planning documents and your retirement account beneficiary designations, as the SECURE Act may have an important impact on your existing estate plan, particularly if your retirement account is one of your largest assets.
1 The 10 Year Rule does not apply to five groups of “Eligible Designated Beneficiaries”: (1) spouses; (2) disabled beneficiaries; (3) chronically ill beneficiaries; (4) minor children of the original IRA owner (but only until they reach the age of majority); and (5) beneficiaries not more than 10 years younger than the IRA owner.