2020 Legislative Update: SECURE Act
On December 20, 2019, President Trump signed a bipartisan, year-end government spending and tax package just hours before federal funding was set to expire. The spending package calls for over $1.7 trillion of government spending. In order to pay for this spending bill, the government funding measure includes substantial changes to retirement savings rules, most notably by accelerating the distribution of tax-deferred retirement accounts, such as 401(k)s and IRAs. Named the Setting Every Community Up for Retirement Enhancement Act (the SECURE Act), this legislation is the most extensive retirement act since the Pension Protection Act of 2006. For those with significant savings in retirement accounts, the SECURE Act requires a re-examination of your estate planning arrangements to maximize tax benefits, preserve assets for beneficiaries, and ensure your estate planning goals continue to be realized. While not a comprehensive list of all changes imposed by this new law, the most important aspects of the SECURE Act, and how they may affect you directly, is included below.
1. Elimination of the Lifetime “Stretch” for Inherited Retirement Accounts
For over 30 years, the typical estate plan for the owners of tax-favored retirement accounts incorporated what was known as the “stretch payout,” which allowed a retirement account inherited by certain “designated beneficiaries”, such as children, to continue to enjoy tax-deferred growth while only requiring the beneficiary to take an annual distribution amount based on the beneficiary’s life expectancy. If a beneficiary only took the Required Minimum Distribution (RMD), he or she could potentially enjoy tax-deferred growth for many decades.
- Non-Designated Beneficiary. A beneficiary that does not qualify as a Designated Beneficiary, such as the account owner’s estate, a charity, or a trust that does not qualify as a “see-through trust” was required to distribute the full retirement account balance by the 5th anniversary of the account owner’s death. This was otherwise known as the five-year payout rule.
- Designated Beneficiary. A Designated Beneficiary, which comprised an individual or a trust that qualifies as a “see-through trust,” was entitled to a payout calculated by the Designated Beneficiary’s life expectancy. A Designated Beneficiary was subject to different rules depending on whether the Designated Beneficiary was a surviving spouse or a non-spouse beneficiary. Designated Beneficiaries received the favorable tax treatment discussed above.
- Non-Designated Beneficiary. Beneficiaries in this category are still subject to the five-year payout rule. Rules under the SECURE Act related to Non-Designated Beneficiaries have not changed.
- Designated Beneficiary. Beneficiaries in this category must distribute the full value of their inherited account by the 10th anniversary of the account owner’s death, unless the Designated Beneficiary is an “Eligible Designated Beneficiary.” If the individual qualified as an “Eligible Designated Beneficiary”, they are entitled to use their life expectancy as the basis for taking distributions from the retirement account.
- The enumerated categories of Eligible Designated Beneficiaries are as follows:
- a) Surviving Spouse. A surviving spouse may still use the life expectancy pay out, as before. Further, the surviving spouse is still entitled to “rollover” an inherited IRA into their own account.
- b) Minor Child of the Account Owner. The life expectancy payout also applies to a “child of the employee who has not reached majority”, which, under Missouri law, would be the age of 18. However, after the child reaches the age of 18, the child must fully distribute the account within 10 years. Notably, this only applies to children of the account owner, and not any individual under the age of 18, or even a grandchild or more remote descendant.
- c) Disabled Beneficiary. The life expectancy payout applies to a Designated Beneficiary who is “disabled”, as defined by § 72(m)(7) of the Internal Revenue Code.
- d) Chronically Ill Beneficiary. The life expectancy payout applies to a designated beneficiary who is “chronically ill”, as defined by § 7702B(c)(2) of the Internal Revenue code
- e) Beneficiary Less Than 10 Years Younger Than Account Owner. Beneficiaries that are less than 10 years younger than the account owner may also take advantage of the life expectancy payout.
2. Using Trusts for Planning with your Retirement Accounts
Under pre-SECURE Act rules, it was common for account owners to designate a trust as the beneficiary of a retirement account, especially if the trust was designed properly as a “see-through trust” which qualified as a Designated Beneficiary. Two types of “see-through trusts” were commonly used as beneficiaries of retirement assets: the Conduit Trust and the Accumulation Trust.
Under a Conduit Trust, required minimum distributions were made from the retirement plan to the trust, and immediately distributed to the trust beneficiary. If designed properly, the conduit beneficiary was considered the sole beneficiary of that trust, and distributions were calculated on his or her life expectancy. With an Accumulation Trust, the trustee was able to accumulate retirement plan distributions in trust, rather than distributing them outright to the beneficiary. Under Accumulation Trust rules, all beneficiaries who might ever be entitled to receive such distributions, even contingent beneficiaries, were considered beneficiaries for purposes of determining life expectancy.
Under the new rules adopted by the SECURE Act, if the primary beneficiary of an existing Conduit Trust is not a Eligible Designated Beneficiary, the trustee of the trust will have to distribute the entire balance of the retirement account within 10 years. Additionally, there are no longer “required minimum distributions” to be made each year to such beneficiary. With respect to existing Accumulation Trusts, the trustee must also make distribution of the entire account balance within 10 years after the account owner’s death, unless it meets the requirements for certain trusts for the sole benefit of disabled or chronically ill beneficiaries.
This change in the rules dramatically changes the tax consequences for those whose estateplans currently use “see-through trusts” as beneficiaries of their retirement accounts. Existing Conduit Trusts could prove disastrous in some cases. For example, the account owner may have wanted a gradual payout of the account over the beneficiary’s lifetime to avoid the beneficiary inheriting a large amount of money in a short period of time, potentially due to creditor issues or irresponsibility. Instead, the entire account balance must be distributed to the beneficiary within 10 years, completely overriding the estate planning goals of the account owner, potentially placing the beneficiary in a precarious situation with creditors, and causing the beneficiary to incur a much larger tax bill than would have otherwise been the case. Accumulation Trusts will still work as planned, in that distributions will still be withheld from the beneficiary rather than distributed outright, but the trustee of the trust will be faced with a substantially higher tax bill due to the accelerated distributions.
3. New Starting Age for Required Minimum Distributions
Although inheritors of IRA accounts may not be pleased with the new changes in the law, the news is not all bad for those counting on retirement accounts to save for retirement and beyond. The SECURE Act pushes back the Required Beginning Date (RBD) for account owners to take RMDs. Under the old law, a retirement account owner was required to begin taking distributions after reaching the age of 70 ½. Under the SECURE Act, account owners may now wait until they are 72 to begin RMDs. This extra year and a half gives account owners more time to consider Roth conversions, defer taxable income, and may help their savings last through their retirement years.
4. Age Limit for Traditional IRA Contributions Removed
Under the old law, IRA contributions could no longer be made once an account owner turned 70 ½. The SECURE Act removes this limitation altogether, allowing affluent account owners to continue making retirement contributions into their golden years, allowing for continued tax deferred growth of their investments.
For those with significant savings in retirement accounts, existing estate plans will still “work” in the sense that the rules defining Designated Beneficiaries have not changed. However, taking into account the new 10-year rule replacing the life expectancy payout for most beneficiaries, many estate plans will not operate in the way they were originally intended prior to enactment of the SECURE Act. As a result, it is vital that you review your current estate planning arrangements to determine if the new law negatively affects your plan, and whether changes need to be made in response. If you have any questions about these new changes to the law, or would like to review your specific estate plan, please do not hesitate to contact any of the experienced estate planning attorneys at Carnahan, Evans, Cantwell & Brown, P.C. in Springfield, Missouri, at (417) 447-4400.