On December 20, 2019, a Federal law relating to retirement plans was enacted, entitled Setting Every Community Up for Retirement Enhancement Act of 2019 (SECURE Act). The law was implemented on January 1, 2020 and impacts retirement accounts and the rules for those who own and inherit them.
Traditionally, individuals with retirement accounts enjoyed tax-deferred growth until they turned 70 ½. At that time, they had to take required minimum distributions (RMDs) – based on life expectancy as determined by the IRS. With SECURE, RMDs must now be taken by April 1 of the year after an individual turns 72 years old. This allows the account to continue to grow tax free longer. People can also now contribute to a Traditional IRA beyond age 70 ½ if still working, allowing even more savings and growth.
These provisions of SECURE recognize that individuals are living longer and retiring later in life. They also incentivize and reward saving for retirement. While SECURE provides benefits to the original account holder, it changed the game for beneficiaries. These changes carry heavy income tax consequences for most inheritors of retirement accounts.
Before SECURE, a non-spouse beneficiary could rollover the account into an inherited IRA. While this required immediate RMDs, regardless of the age of the beneficiary, the account would continue and “stretch” for their lifetime. This meant more tax-deferred growth. To illustrate: take the case of a 95-year-old mother leaving behind a Traditional IRA for a 65-year-old son. According to the IRS, at the age of 95, mom’s life expectancy would have been 8.6 years. This means that her RMD was calculated by taking the account balance as of December 31 of the prior year and dividing by 8.6. For an account with a $300,000 balance, mom’s RMD would be just under $35,000 for the year. Upon her death, her son would have inherited the IRA and based on his life expectancy of 21 years, he would have only had an RMD of about $14,000.
SECURE changed this drastically. Now, with a few narrow exceptions, the son must take a payout of the entire account in 10 years, regardless of his age. Remember that these assets are income tax-deferred so a full distribution of the account is taxable as income. Think of the procrastinating beneficiary who waits until year ten and must take over $300,000 in taxable income at once. Also, a beneficiary with creditor concerns or going through a divorce must now take a payout during a potentially dangerous time.
These concerns likely necessitate a beneficiary seeking the counsel of an accountant and/or financial advisor to plan distributions. The creditor concerns also raise the issue of how to protect beneficiaries. Enter the beneficiary trust with accumulation provisions for inherited retirement accounts.
While the accumulation trust was an important tool for protecting beneficiaries before SECURE, the accelerated payout has made it even more crucial. The original account holder will name the trust as the beneficiary of the Traditional IRA account instead of an individual. The trust allows the inherited IRA distributions to be taken over the course of the ten years, but remain in the trust. Depending on the selection of trustee and the terms of the trust, the distributions are paid out to the beneficiary or can accumulate and grow. For a beneficiary with a creditor, divorcing spouse, or estate taxes, the monies that remain in the trust stay protected.
Without a doubt, SECURE changed the landscape for retirement assets, the way they are used during life and how we leave them behind at death. Educating yourself and beneficiaries about how these changes impact your own situation is imperative to creating the most efficient estate plan. Due to the complexities of the SECURE Act, it is crucial to seek an estate planning attorney knowledgeable in retirement planning.