If 2017 was the year of significant tax reform, 2019 will go down as the year of considerable retirement reform. The Setting Every Community Up for Retirement Enhancement Act, also known as the SECURE Act, was signed into law on December 20, 2019, and became effective January 1, 2020. The Act makes substantial changes to how retirement accounts can be funded, drawn down, and passed on to the next generation.
The SECURE Act could possibly undermine a previous estate plan. On the surface, most clients’ estate plans will still “work” for retirement accounts in that their designated beneficiary — whether an individual or a trust — will remain in place. However, if you dig under the surface, most estate plans will not work in the way they were initially designed for the administration and distribution of retirement accounts.
SECURE Act Changes
You cannot keep assets in a retirement account forever. After a certain point in life, the owner of an account (unless it is a Roth account) is required to begin drawing down required minimum distributions (RMD). If a retirement account is not depleted during the life of a participant, a beneficiary will have to draw down the remaining funds over a certain period of time as the beneficiary’s RMD.
This has all been true about IRAs for decades. However, the SECURE Act substantially changes the RMD timelines.
Change 1: Elimination of Maximum Age Requirement for Traditional IRAs
The SECURE Act eliminates the maximum age at which an individual can make contributions to a traditional IRA. Before the new law, an individual could not contribute to a traditional IRA after 70 ½. Now, he or she can continue to contribute as long as they work.
Change 2: Increased Age Requirement for Required Minimum Distributions
Under the new law, RMDs for the account owner are deferred until age 72, instead of age 70 ½. Pushing back the RMD start date gives individuals additional time for their IRAs and qualified retirement plans to grow without being diminished by distributions and taxes.
These two changes mean that retirement accounts can grow even bigger than before; but a bigger pot means a bigger challenge for planning purposes, especially when you consider the third and most crucial change below.
Change 3: 10 Year Beneficiary Drawdown, or the Death of the “Stretch IRA”
Before the SECURE Act, if a beneficiary (other than a spouse) inherited an IRA, the RMDs were calculated based on the beneficiary’s lifetime. The individual could “stretch” the IRA distributions over their lifetime, allowing more money to remain in the account and grow income-tax free—hence the name “Stretch IRA.” Accordingly, a 25-year-old beneficiary (with a life expectancy of 58.2 years) would have a relatively small required distribution. If a trust were used as a beneficiary, we could “see through” the trust to find the beneficiary whose lifetime would be used for “stretch” purposes.
Under the SECURE Act, the “Stretch IRA” is a relic of the past. The Act eliminates the stretch option and replaces it with a 10-year payout for most beneficiaries, with a few exceptions: a surviving spouse, a minor child, a disabled or chronically ill beneficiary, and beneficiaries who are less than ten years younger than the original owner. For everyone else, this means that the RMDs for a beneficiary will be much larger and will result in an acceleration of income taxes due. This change is the main reason most estate plans will no longer work in the way they were intended.
The bottom line is inherited retirement accounts will not provide the same benefits as a result of the SECURE Act. Estate plans using trusts that were designed to take advantage of the beneficiary lifetime “stretch” will no longer be as effective for income tax and asset protection planning. Trusts for individual beneficiaries may still be the appropriate choice, but alternative planning with IRAs, like using IRA funds for charitable gifts, may now be desirable. There is no one universal fix to update all clients’ situations because changes will affect different clients in very different ways. Some will be able to maintain their estate plan with a few changes or no changes, but others may require a significant overhaul.
We recommend any plan involving a retirement account be reviewed by a trusted advisor. The attorneys at MendenFreiman are here to provide you with the tools to help navigate you and your family through the new SECURE Act. Contact us today to explore new planning opportunities.