On Jan. 1, 2020, the Setting Every Community Up for Retirement Enhancement Act (SECURE Act) went into effect, and it represents the most significant retirement-planning legislation in decades.
Indeed, the changes ushered in by the SECURE Act have dramatic implications for both your retirement and estate planning strategies—and not all of them are positive. While the law includes a number of taxpayer-friendly measures to boost your ability to save for retirement, it also contains provisions that could have disastrous effects on planning strategies families have used for years to protect and pass on assets contained in retirement accounts.
Given this, if you hold assets in a retirement account you need to review your financial plan and estate plan as soon as possible. To help you with this process, here we’ll cover three of the SECURE Act’s biggest changes and how they stand to affect your retirement account both during your lifetime and after your death.
Increased age for Required Minimum Distributions (RMD)
Prior to the SECURE Act, the law required you to start making withdrawals from your retirement account at age 70 ½. But for people who haven’t reached 70 ½ by the end of 2019, the SECURE Act pushes back the RMD start date until age 72.
Repeal of the maximum age for IRA contributions
Under previous law, those who continued working could not contribute to a traditional IRA once they reached 70 ½. Starting in 2020, the SECURE Act removed that cap, so you can continue making contributions to your IRA for as long as you and/or your spouse are still working.
These two changes are positive because with our increased life spans people are now staying in the workforce longer than ever before, and the new rules allow you to continue contributing to your retirement accounts and accumulating tax-free growth for as long as possible.
However, to offset the tax revenue lost due to these beneficial changes, as you’ll see below, the SECURE Act also includes some less-favorable changes to the distribution requirements for retirement accounts after your death.
Elimination of stretch provisions for inherited retirement accounts
The part of the SECURE Act that’s likely to have the most significant impact on your heirs is a provision that makes significant changes to distribution requirements for inherited retirement accounts, and effectively ends the so-called “stretch IRA.”
Under prior law, beneficiaries of your retirement account could choose to stretch out distributions—and, therefore, the income taxes owed on those distributions—over their own life expectancy. For example, an 18-year old beneficiary expected to live an additional 65 years could inherit an IRA and stretch out the distributions for 65 years, paying income tax on just a small amount of their inheritance every year. And in that case, the income tax law would encourage the child to not withdraw and spend the inherited assets all at once.
Under the SECURE Act, however, most designated beneficiaries will now be required to withdraw all the assets from the inherited account—and pay income taxes on them—within 10 years of the account owner’s death. Those who fail to withdraw funds within the 10-year window face a 50% tax penalty on the assets remaining in the account.
The law does offer exemptions to the mandatory 10-year withdrawal rule for certain beneficiaries, known as eligible designated beneficiaries (EDB):
- 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.
- Beneficiaries who are less than 10 years younger than you can still take distributions based on their own life expectancy.
- Your minor children, who have not reached the “age of majority” don’t have to deplete the account until 10 years after they come of age. Yet that still would be a much shorter “stretch” than previously available.
- Disabled individuals and chronically ill individuals can take distributions based on their life expectancy.
Apart from these exceptions, opportunities for stretching an IRA over an extended period of time are no longer available. This means if you want the people who will inherit your retirement account after your death to benefit from long-term income tax deferral—as well as asset protection from lawsuits, creditors, or divorce—you must meet with us now to rework your plan.
Impact on trusts
Depending on the value of your retirement account, you may have already addressed the distribution of its assets using a “conduit” provision in your will, revocable trust, or standalone retirement trust. Prior to the SECURE Act, a trustee of a trust that included a conduit provision would only distribute the required minimum distributions (RMD) to trust beneficiaries each year.
This allowed the beneficiary to take advantage of the continued “stretch” based on their age and life expectancy. In this way, the conduit trust protected the account balance and only exposed the much smaller RMD amounts to creditors and divorcing spouses.
Under the SECURE Act, however, the 10-year limit for taking distributions will lead to the acceleration of income tax due, possibly bumping your beneficiaries into a higher income tax bracket. This potentially hefty tax burden would likely result in your beneficiary receiving significantly less funds from the retirement account than you had initially planned on.
What’s more, because the SECURE Act requires all funds in your retirement account to be withdrawn within 10 years after your death, a conduit trust would be required to distribute all of its assets outright to the beneficiary within this shortened period. This means you would also lose any long-term asset protection you may have built into your plan.
Alternative options
Given the SECURE Act’s new rules, you may want to consider amending your trust to shift it from a “conduit trust” to become an “accumulation trust.” Such a trust structure can’t extend the tax benefits any longer than 10 years, but it can ensure the assets are protected from your beneficiary’s future risky activities and/or a divorce.
One important thing to note
Retained distributions from a traditional IRA distributing to an accumulation trust would be exposed to compressed income tax rates that apply to trusts. Currently, trusts reach the maximum 37% tax bracket with undistributed taxable income of $12,950. Facing such a tax hit, if you opt for this solution, your plan should include additional strategies to address the tax obligation.
UPDATE YOUR ESTATE PLAN NOW
We can update your plan to address all of the potential ramifications the SECURE Act might have on the distribution of your retirement account’s assets to your loved ones following your death. But to do that, we need to meet with you to consider your family dynamic and all of your assets, so we can thoroughly assess the big-picture impact the SECURE Act stands to have on your estate.
This is exactly what we do during our Family Vision Meeting – a two-hour working meeting that educates and empowers you to know you’ve done the right thing for the people you love no matter what happens to you. Whether you’ve yet to create a plan or already have one created another lawyer, schedule an appointment with Pierchoski Estate Law today.
A Note from the Attorney, Stan Pierchoski:
The practice of law is a second career for me. After obtaining Master of Science degrees in both Nuclear and Mechanical Engineering, I worked in the Nuclear Power Industry for 15 years. Always having an interest in law, I attended and graduated from law school and founded the Pierchoski Law Firm in 2002 in Pulaski, TN. For several years I practiced as a criminal defense, trial attorney. After my parents passed I became interested in Trust and Estate Law and felt a strong calling to change my practice to the Estate Planning area.
For years I have been exclusively doing trust writing and wealth planning and have become proficient at it. Over the last several years my practice has evolved to serve all age groups including elders and Medicaid Planning. I am always open to your questions and am more than happy to chat with you about your concerns so give me a call or stop by my office. You’ll be glad you did!