On January 1, 2020, President Donald Trump signed into law the Setting Every Community Up for Retirement Enhancement (SECURE) Act. As an estate planning attorney, I recognized this as a significant change that effects a lot of people. Because the Act moved rather quickly through the House and Senate, many of the details and nuisances of the new act still have yet to be understood and interpreted. When you couple that with being hit by a pandemic shortly thereafter, even Tax attorneys and CPA have been delayed in trying to digest all of the ramifications that these changes entail.
A Historical View
The declared purpose of the SECURE Act: enhance the accessibility and flexibility of tax-deferred retirement saving vehicles. While there are many provisions that are considered welcome updates, there are also significant changes with increased tax consequences. Before the SECURE Act, a person who was 70 ½ years of age or older could not contribute any longer to their IRA even if they were still working. Also, at age 70 ½, the government required the IRA owner to start taking money out of the IRA. The amount is a calculation known as the required minimum distribution (RMD). Interestingly, 401(k) accounts do not have these age restrictions for contributions, and 401k account owners do not have to take an RMD at 70 ½ if they are still working.
The age limit of 70 ½ for IRAs was put in place in the 1960’s. However, we are living longer and people are working later into their lives, so it certainly seems reasonable to make these changes. But there is one noted drawback: the Joint Committee on Taxation (JCT) estimates that raising the RMD age from 70 ½ to 72 would cost the government $8.9 billion in lost revenue over the next 10 years.
Increased Taxes on Our Children
Congress has the philosophy that these tax-deferred accounts are designed to provide people with “individual retirement security”. They are a way for a person to save money to enhance and support their retirement. Therefore, Congress believes that the account owners would spending their retirement savings during their lifetime instead of using it as a vehicle to transfer wealth across generations. As a result, the SECURE Act incorporates a provision — arguably the most consequential one — that mandates most inherited retirement account balances be distributed (and therefore completely taxed) within 10 years after the account owner’s death.
Prior to the SECURE Act, a commonly used wealth-planning strategy was to name a younger beneficiary, like child or grandchild), who could then elect to have the account balance distributed out to them over the young beneficiary’s lifetime. Some families would even ensure this lifetime payout benefit by using a Conduit Look-Through Trust, which would then be named as the primary beneficiary of the account. This “stretch IRA” strategy has had incredible tax benefits over the years including:
Allowing the assets to continue to grow tax deferred after the original account owner’s death.
Allowing if the account owner to only take the RMD each year, leaving more assets in retirement accounts that could potentially grow faster than the RMD withdrawals.
Allowing the account owner to reduce the tax consequences since young child or grandchild could stretch the distributions over a long period. This occurs because having smaller distributions across the life of the beneficiary is less likely to force them into a higher income tax bracket verses a large lump sum payout or large distributions.
Unfortunately, the SECURE Act destroy the stretch and now shortens the distribution period for most beneficiaries from their lifetime to just 10 years from the date of the account owner death.
4 Major Exceptions To The Required 10-Year Withdraw Rule:
*spousal beneficiaries (they still get the stretch)
* beneficiaries who are no more than 10 years younger than the original IRA owner (which could apply to beneficiaries who are siblings or unmarried partners)
* disabled and chronically ill beneficiaries, or
* beneficiaries who are minor children (but not grandchildren) of the account owner, have the 10-year rule delayed until the child reaches the age of majority, which is age 18 in most states
By restricting the stretch IRA, congress estimates an increase in revenue by $15.7 billion over the next 10 years.
While this article could go on and on for a few more pages, it highlights many of the major issues that effect everyone. Here are a few of the other provisions of the Act:
• Eliminates the age limit on contributions to IRAs
• Reduces the maximum period over which an inherited IRA has to be withdrawn- no more lifetime stretch for our Children or grandchildren!
• Extends the minimum age for the Required Minimum Distribution (RMD) to age 72
• Allows small employers to join together to provide 401(k) plans for employees
• Allows part-time workers to enroll in 401(k) plans
• Provides the ability for 401(k) plans to provide annuities as a payout option for lifetime income
• Allows new parents to withdraw up to $5,000 per parent from their tax-preferred retirement saving accounts without penalty
All of this is likely leaving you wondering, “Well, now what do I do?” Stay tuned, as we will be laying out several, potential options in next month’s newsletter. In the meantime, if you know it is time for a change to your estate plan, feel free to contact our office for a free 30 minute consultation by phone or by video conference. You can reach us at (888) 787-1913 or email legalteam@twestateplanning.law.