Your Estate Plan May Need To Be Tweaked: The SECURE Act Has Passed

The Setting Every Community Up for Retirement Enhancement Act (SECURE Act) was signed into law on December 20, 2019 and goes into effect on January 1, 2020. It is the most impactful legislation affecting retirement accounts in at least a decade.

If your estate plan distributes assets to your beneficiaries in trust, you should contact your estate planning attorney immediately to discuss whether your Will or Revocable Trust should be amended in light of the new legislation.

Positive Changes Associated with SECURE Act

The SECURE Act brings some positive changes:

1. It delays the age for required minimum distributions from retirement accounts from 70 ½ to 72 years of age for distributions made after December 31, 2019; and
2. It repeals the maximum age for contributing to traditional IRAs, allowing individuals over age 70 ½ to contribute to an IRA if they are still working or their spouses are still working.

The Death of the Stretch IRA for Most Beneficiaries

Despite the positive changes, the SECURE Act imposes less favorable distribution requirements for most beneficiaries.

Under the old law, designated beneficiaries of inherited retirement accounts could elect to take distributions over their individual life expectancy. For example, an 18-year old beneficiary with a 65-year life expectancy would stretch out the distributions over 65 years. This allowed a beneficiary to minimize the amount withdrawn in any year, which contributed to more income tax-deferred growth.

In contrast, the SECURE Act requires most designated beneficiaries to withdraw the entire balance of an inherited retirement account within ten years of the account owner’s death.

The SECURE Act does provide a few exceptions to this new mandatory ten-year withdrawal rule:

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 can still take distributions based on the beneficiary’s life expectancy.
3. The account owner’s children who have not reached the“age of majority” don’t have to deplete the account until 10 years after they reach the “age of majority.”
4. Disabled individuals and chronically ill individuals can take distributions based on their life expectancy.

But apart from these exceptions, opportunities for stretching the IRA over an extended period of time will no longer be available.

Estate Planning Ramifications of SECURE Act

If your current estate planning documents created trusts to hold retirement assets, you should contact your attorney right away to discuss whether they will still achieve your estate planning goals and objectives.

Many estate plans that created trusts to hold retirement assets for asset protection purposes included conduit trust provisions. “Conduit” trusts require a trustee to distribute all required minimum distributions directly to the beneficiary. These provisions are a safe harbor see-through trust, which allows the primary beneficiary of the trust, rather than the trust itself, to be the designated beneficiary and measuring life for purposes of determining the required minimum distribution.

Under the SECURE Act, conduit trust provisions would require the trustee to distribute the balance of the account outright to the beneficiary within ten years after the account owner’s death. This is an outcome many clients may wish to avoid if asset protection was a driving force in creating the trust.

An accumulation trust would allow a trustee of a trust to accumulate distributions from a retirement account in the trust, and to exercise discretion as to when and how to distribute the funds to the beneficiary. However, accumulation trusts have their own drawbacks. There are no requirements that the trustee make distributions to beneficiaries and can retain distributions from retirement plans in trust. However, retained distributions from traditional IRAs are subject to compressed income tax rates that apply to trusts. Currently, trusts reach the maximum tax bracket with undistributed taxable income of $14,450.

Although the trust will pay income tax on retained distributions, and plans should be made to address how to pay those taxes, for many beneficiaries, a client’s desire to protect the money from the beneficiary’s creditors, divorces, or lawsuits may override the tax implications.

Financial Planning Ramifications of SECURE Act

This is also a great time to contact your financial advisor to discuss the changes brought about by the SECURE Act and how that fits into your overall financial plan.  As I mentioned in my article in August about preparing for the death of the Stretch IRA, IRA Expert, Ed Slott, has written some articles suggesting different planning strategies under the new law.

One option to consider depending on your age, size of your retirement plan, and your goals, involves converting traditional IRAs to Roth IRAs. Although this would result in significant income tax ramifications in the short term, and the SECURE Act will still mean a loss of future tax-free growth, the ten-year payout rule will not increase the beneficiary’s income tax bill since distributions are tax-free. Additionally, there would be no tax on distributions from inherited Roth IRAs to an accumulation trust.

Another strategy that Slott recommends is withdrawing some of the IRA to invest in life insurance to offset your beneficiaries’ increased tax liability. If asset protection is a consideration, you may wish to direct death benefits into a trust for your beneficiaries. This will avoid tax rules associated with withdrawals of retirement plan assets, and allow for asset protection for the trust assets.

Planning for Those with Charitable Inclinations

Those with charitable inclinations can make use of charitable remainder trusts (CRTs). The CRT could be named as the beneficiary of an IRA. After the IRA’s owner passes away, the trust can make monthly, quarterly, semi-annual or annual distributions for a beneficiary’s lifetime. When the trust terminates, the named charity would receive the remaining trust assets.

Inherited retirement accounts will not provide the same benefits post-SECURE Act, but your estate planning attorney and financial advisor can help you navigate the new rules to provide you with peace of mind and ensure your retirement assets are passed to your beneficiaries in the most efficient and protected manner.