On December 20, 2019, President Trump signed into law the SECURE Act. Short for “Setting Every Community Up for Retirement Enhancement,” the new law has sweeping, long-term implications for beneficiaries of and contributors to retirement accounts.
Under the old rule, when an account holder passed away, the remaining balance of their retirement account could to be distributed in annual installments over the life expectancy of their designated beneficiary. Alternatively, if a beneficiary were not named, the benefits would have to pass through the estate, and the ultimate beneficiary had to withdraw the benefits within five years of the account holder’s death if the account holder died before they reached age 70.5 – the age when required mandatory distributions must be taken.
The SECURE Act changes this rule and others predicated on age. For starters, the age for required minimum distributions (RMDs) jumps to 72 years from 70.5 years, and contributions can be made to an IRA without age restrictions so long as the individual remains working. Under the old rules, contributions were halted at age 70.5.
Also new, SECURE permits more liberal withdrawals for those who have had a baby or adopted a child. Under SECURE, Americans can withdraw up to $5,000 from their retirement accounts, including 401(k)s and IRAs, without paying the usual 10% penalty.
One of most significant changes incorporated in SECURE surrounds the transfer of legacy wealth through IRA Trusts that benefit non-spousal account inheritors. Previously, the primary goals of an IRA Trust were (1) to take advantage of the “stretch” of taxable RMDs by allowing the money inside the IRA to compound tax-free, making more wealth available down the road; and (2) to maximize asset protection and management of inherited IRAs from spendthrift issues and creditors of the intended beneficiary.
Now, under the much discussed “10-year rule”, non-spousal beneficiaries must withdraw all assets of an inherited account within 10 years of the death of the original account holder or the death of the death of an eligible designated beneficiary (“EDB”), such as a spouse. Beneficiaries who do not fit into one of the five exceptions that would categorize them as an EDB may withdraw whatever they like within the 10 years, which allows some flexibility in tax planning. However, this rule has many concerned because the majority of non-spouse 2nd tier beneficiaries will fall between 40 and 60 years old, which is when people are typically earning the most and landing in the highest tax brackets.
There are options contributors to retirement accounts can take to make the best of SECURE’s rule changes in lieu of a traditionally used conduit IRA Trust. Among them:
- Convert your IRAs to Roths – By doing so, you will pay the taxes up front so that your beneficiaries aren’t inundated with a significant tax bill at an inopportune time when they are compelled to withdraw at the end of the 10 year period.. Right now, there is no income cap in place for an individual to convert their traditional IRA to a Roth.
- Change conduit trusts to accumulating ones – Pre-SECURE, IRA trusts were often drafted as “conduit” trusts. In a conduit IRA trust, all IRA distributions (including RMDs) would pass to the primary beneficiary; however, the primary beneficiary may use their own life expectancy for purposes of RMDs, thus creating the “stretch.” This could create a problem under SECURE where the only real RMD is at the 10-year mark. Alternatively, by drafting an IRA Trust as accumulating, the trust retains the IRA assets after the 10-year period and distributions are discretionary/left to the trustee. An accumulation trust, unlike a conduit trust, allows distributions from the IRA to be retained by the trust.
- Convert to a Charitable Remainder Trust (CRT) – Changing current IRA trusts to CRTs will allow a steady income stream to the beneficiary for those account holders that are more charitably minded.
- Buy life insurance at age 59.5 (or thereafter) – At this age, there is no longer a 10% penalty for early withdraw on an IRA, however standard income taxes will be applicable At that time, or thereafter, an account holder can withdraw all or part of their IRA and purchase a comparable whole life policy. This policy would create an income stream, and select an irrevocable trust as its beneficiary. However, there are significant logistical issues regarding how much a policy of that size, at that age, would cost. This option would require a careful calculation of the cost benefit for each individual case.
There is a great deal of uncertainty surrounding the enactment of the SECURE Act, the first significant retirement legislation in more than a decade. This new law brings plenty of new options and challenges for you to consider while contemplating the best retirement strategies – or the windfall coming to you from someone else’s retirement account. The right advice and decisions will go a long way in determining how well you handle your bequest or receipt of legacy wealth.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.