On January 1, 2020, as we entered another year without any idea of what was on the horizon, a new federal law took effect regarding retirement accounts. The SECURE Act, “Setting Every Community Up for Retirement Enhancement”, affects millions of Americans who have been saving through tax-deferred retirement plans. The biggest impact falling those set to inherit these plans. Now, two years later, SECURE is still a new concept for many clients who are unaware of the law or how it applies to their own situation.
One change is the age at which a plan holder must take required minimum distributions (“RMDs”) was increased from 70 ½ to 72. RMDs are taken annually, based on the full value of the account on December 31 of the prior year and the life expectancy of the plan holder. The delay to age 72 will result in a year and a half more of tax-deferred growth on the funds.
There are some new allowable penalty free withdrawals. SECURE also created a $10,000 penalty-free withdrawal for someone giving birth to or adopting a child. The Act also expanded the ability for small business owners to offer retirement plan funding. However, the most drastic item in SECURE takes aim at the beneficiary of the plan after the death of the original plan holder.
Prior to SECURE, a non-spouse designated beneficiary had the option of converting the plan to an inherited IRA and taking a RMD based upon their own life expectancy. The beneficiary could take more than the RMD if needed, realizing that each distribution is taxable income. Consider a 90-year-old with an IRS life expectancy of 12.2 years who names a 65-year-old child as designated beneficiary. A 65 year old has an IRS life expectancy of 22.9 years. That beneficiary could previously “stretch” the distributions over their life expectancy and allow those funds to grow tax-deferred for many more years. With SECURE, this stretch is lost for the majority of beneficiaries. SECURE prescribes a mandatory 10-year payout for a designated beneficiary. Being forced to liquidate in the 10 years will result in the payment of more income taxes than if the beneficiary had the 22.9-year payout.
The SECURE Act carved out limited exceptions to this 10-year payout rule. These five categories of designated beneficiaries include:
minor child of the plan holder (not a grandchild);
chronically ill person;
disabled person; and
or a person not more than 10 years younger than the plan holder.
If you have retirement assets, this change serves as a trigger to have your plan reviewed by your estate planning attorney and financial advisor. This review is especially important where an estate plan includes a trust as the beneficiary of a retirement account. The terms of the trust may need to be adjusted from being a conduit trust to an accumulation trust. A conduit trust forces all distributions out to the beneficiary, whereas an accumulation trust allows the distributions to remain protected in the trust. Other clients may decide to leave tax-deferred retirement assets to charities rather than individuals. Still others may rearrange allocations to make IRAs payable to a person not less than 10 years younger than them, such as a sibling. Thereby focusing on saving other types of assets for beneficiaries otherwise forced to take a 10-year taxable payout.
Many Americans have spent their working lives contributing to tax-deferred plans with the idea that it will give them a stream of income in retirement, and pass on to their beneficiaries as a stream of income. While SECURE may not alter the plan for some, the impact of SECURE should be considered by all. Stay tuned for future updates because there are already whisperings about SECURE 2.0 which, among other things, may raise the age at which RMDs are required.