On May 23, 2019, the U.S. House of Representatives passed the Setting Every Community Up for Retirement Enhancement Act of 2019 (H.R. 1994) referred to as the SECURE Act. The SECURE Act passed with broad support in the House with a vote of 417-3. The SECURE Act incorporates many provisions in Retirement Enhancement Savings Act of 2019 (S. 972), also known as RESA, which has extensive bipartisan support in the Senate. Recently a small group of Senators blocked passage of RESA in an attempt to allow 529 Plan funds (educational savings account funds) to be used to support home-schooling. However, due to generally strong bipartisan support in the Senate and House as well as retirement plan industry support, it is expected that some form of RESA will ultimately pass, the two bills will be reconciled, and that the reconciled bill will become law.
The SECURE Act makes it easier for many Americans to save for retirement. Most of the provisions provide more flexibility to employers and reduce administrative costs regarding creation and implementation of employer related retirement plans. It is hoped that these reforms will allow employers to create more robust retirement plans and to encourage their employees to participate in such plans.
Although the SECURE Act’s focus is on employer related retirement plans, there is one provision that would have a significant impact on the transfer of qualified retirement plan assets upon death. Currently, beneficiaries who inherit IRAs and other qualified retirement plan assets can elect to receive distributions from those plans over their remaining lifetimes. This is often referred to as the “stretch provision.” Thus, under the current law, a beneficiary who inherits qualified retirement plan account benefits must withdraw a minimum required distribution (“MRD”) from the account annually. The beneficiary may withdraw more than the MRD from the account; but is subject to penalties if the beneficiary withdraws less than the MRD. All distributions from such plans (other than Roth IRAs or Roth 401Ks) are subject to income tax as ordinary income in the year distributed.
The MRDs are determined based on the life expectancy of the beneficiary at the death of the decedent. Thus, younger beneficiaries, such as a decedent’s children, who inherit qualified retirement plan assets may withdraw funds over a long period of time, deferring realization of income tax and allowing assets in the plan to continue to grow income tax free. For example, a 50 year old who inherits retirement plan benefits can withdraw those benefits over 34 years. In addition, the MRDs are not uniform over the period but rather increase as the beneficiary ages. Thus, with a 50 year old beneficiary, the beneficiary must withdraw only 1/34th of the account value in the first year after inheriting the retirement benefits, allowing the remaining assets in the account to continue to grow. Each year, the beneficiary must increase the numerator of the fraction by one; thereby increasing the MRD. It is true that those who inherit qualified retirement plan accounts with a modest amount of funds often liquidate them quickly. However, those who inherit accounts with higher balances benefit from the income tax deferral allowed by the stretch provisions.
The SECURE Act would change the system regarding the stretch provisions. Instead of allowing a beneficiary to withdraw MRDs over his or her lifetime, the SECURE Act requires a beneficiary to withdraw all of the assets in the inherited qualified retirement plan within 10 years of the decedent’s death. For many beneficiaries of qualified retirement plans with significant balances, this will accelerate withdrawals from a qualified retirement plan and accelerate the realization of ordinary income tax on the plan assets. In addition, the beneficiary will lose the ability to continue to invest the qualified retirement plan assets income tax free over his or her lifetime.
The SECURE Act does allow for certain exceptions to the 10-year rule. If the beneficiary is the decedent’s spouse, he or she can continue to “rollover” the benefits into his or her own account and will be treated as the owner. In addition, there are exceptions for beneficiaries who are minor children of the decedent, disabled, chronically ill or less than 10 years younger than the decedent. For minor children, the 10 year payout period does not begin until the child reaches the age of majority.
Since the Senate has not passed RESA, it remains to be seen how the MRD rules will be changed for beneficiaries of qualified retirement plans after the death of the recipient. However, those with large qualified retirement plan account balances should pay attention to these changes and, if enacted, consider whether any adjustment to their designated beneficiaries is warranted.
