The 'SECURE' Act Modifies Distribution Rules for Retirement Accounts After Death
The SECURE (“Setting Every Community Up for Retirement Enhancement”) Act was enacted as part of the Further Consolidated Appropriations Act, 2020 on December 20, 2019. The SECURE Act modifies a number of rules for tax-advantaged retirement accounts (including both employer-provided qualified retirement plans and IRAs) that may impact the operation of your established estate plan.
Some of the key changes that took effect on January 1, 2020 include:
(1) IRA owners over age 70 1/2 will be able to continue contributing to their traditional IRAs if they are still working or their spouse is still working.
(2) Required minimum distributions from qualified retirement plans and IRAs will begin at age 72 rather than age 70 1/2 for all plan participants and IRA account owners who did not reach age 70 1/2 by December 31, 2019.
(3) Tax-advantaged 529 accounts can be used to repay qualified student loan debt and costs of apprenticeship programs (up to $10,000 annually).
(4) Qualified retirement plans and IRAs must be distributed within 10 years of the plan participant’s or IRA owner’s death, unless one of five classes of special beneficiaries is named (see below).
In the context of estate and retirement asset planning, the most significant change is item (4) above - the elimination of the “stretch IRA,” which previously allowed beneficiaries of qualified retirement plans and IRAs to stretch out disbursements over their lifetimes, thereby maximizing the tax-free growth of the assets and deferring income tax liability as long as possible. Under the SECURE Act, only select “eligible designated beneficiaries” will be entitled to a modified version of the life expectancy payout rules. “Eligible designated beneficiaries” include a surviving spouse, a minor child of the plan participant or IRA owner (until reaching age of majority, at which point the 10-year payout rule kicks in), a disabled beneficiary, a chronically ill beneficiary, or an individual who is less than 10 years younger than the plan participant or IRA owner. When a retirement plan pays out to a participant’s estate, a charity, or a trust that does not qualify as a designated beneficiary, the previous 5-year payout rules still apply. All other beneficiaries must withdraw benefits within 10 years of the death of the plan participant or IRA owner.
In light of this new law, clients are encouraged to review their retirement account beneficiary designations and consider if changes may be in order. Whereas before it was often favorable to name a “conduit trust” as a beneficiary (which would require that retirement benefits be paid to the trust beneficiary as they were received and often over the course of the beneficiary’s lifetime), a conduit trust may now require that those benefits be paid out over only 10 years. If it would still be beneficial to use a trust as part of the estate plan, it may be appropriate to now use an “accumulation trust.” An accumulation trust allows retirement plan distributions to be held in trust and paid out over the life of the trust at the Trustee’s discretion.
No matter which trust is used, in most cases the SECURE act will cause the retirement benefits to be taxed within 10 years of the participant-owner’s death, but the choice of trust can have a significant impact on the amount of that tax. A conduit trust causes the benefits to be taxed directly to the trust beneficiary at the beneficiary’s rates, but benefits paid to an accumulation trust will be taxed at trust tax rates unless the funds are actually distributed to the beneficiary. The trust tax rates may be substantially higher than the beneficiary’s individual tax rate.
Estate planning clients will want to review the tradeoffs of trust protection with the income tax consequences of each type of trust, bearing in mind the possible payout ages for beneficiaries given the new SECURE Act rules. If you would like to review how the SECURE Act will impact your retirement account planning and overall estate plan, please contact a member of the Stokes Lawrence Estate Planning Group.