The SECURE (Setting Every Community Up For Retirement Enhancement) Act, passed by Congress and made effective as of January 1, 2020, made momentous changes to the Federal Tax Code and its rules regarding distributions from retirement accounts including 401(k) and 403(b) plans, IRAs, and tax-qualified annuities (referred to in this article as “Retirement Plans”). These changes might affect you, as the owner of one or more Retirement Plans during your life, as well as the persons who inherit these accounts as the named beneficiaries of your Plan at your death. Because the Act can result in unexpected income and tax and other consequences to you and your beneficiaries, you should speak with your estate planning attorney about these changes now. In the meantime, let us review the Act’s most significant changes briefly.
How Will the Act Affect You as Owner? The answer is a favorable one. Among its many changes, the SECURE Act changes the age at which a Retirement Plan owner must begin taking Required Minimum Distributions (RMDs) from the Retirement Plan. Prior Federal tax law required an owner to begin taking RMDs by April 1 of the year after the year in which he or she turned 70 The SECURE Act has extended this age to 72 and applies to those who turn 70 n 2020 or after. This change might make a Roth IRA conversion advantageous for persons under age 72.
Another change by the Act is that there is no longer an age limitation for funding traditional IRAs. Prior Federal law restricted deductible and nondeductible contributions to a traditional (non-Roth) IRA to qualifying persons under the age of 70 1/2. The SECURE Act has removed this age cap. In certain situations, this change might allow for certain additional opportunities to fund a Roth IRA.
How Will the Act Affect Your Beneficiaries? The answer is … It depends. Most notably, the SECURE Act has dramatically restricted the ability of certain account holders of inherited retirement accounts to “stretch” their distributions over their life expectancy. Prior law permitted certain beneficiaries to stretch the distribution of their inherited retirement accounts over their life expectancy, thereby allowing the undistributed balance in their accounts to continue to grow tax-free. Prior law also allowed one to leave one’s retirement account to a trust which, if properly drafted to satisfy Federal tax law, could direct distributions to a beneficiary for life while also protecting such distributions from creditors of the beneficiary, and allowing the balance remaining in the account at the beneficiary’s death to be held for one’s other family members.
The SECURE Act has curtailed these very favorable prior options, thereby curtailing additional years of income tax deferral and of tax-free growth. Most beneficiaries under the new Act must receive the entire amount of their inherited retirement account within 10 years of the death of the person who funded the Retirement Plan. There are, however, 5 excepted categories of designated beneficiaries to whom this new rule applies: (1) your surviving spouse, (2) your minor children (but not your grandchildren), (3) disabled individuals, (4) chronically ill individuals, and (5) individuals who are not more than 10 years younger than you. Note that on the death of the eligible designated beneficiary or the attainment of majority of a minor child, the 10-year payout rule will apply.
Given the potentially complex effects of the Act on your Retirement Plans and your estate plan, what action should you and your estate planning attorney take right now?
- Review your current beneficiary designations of each of your Retirement Plans.
- Review your current estate plan, including your Will, any trusts you have created (either as part of your Will or as one or more independent trust documents), and your financial/legal Power of Attorney.
- Review the projected changes to distribution and income taxation of your beneficiaries under actions 1 and 2, above, given the Act’s new rules. Are these consequences what you intended, or must you make changes to prevent unintended or unfavorable results?