On December 20, 2019, President Trump signed the Setting Every Community Up for Retirement Enhancement Act (SECURE Act). The SECURE Act went into effect on January 1, 2020, and will have a huge impact on retirement funding.

There are several positive changes. Under the SECURE Act, the age for required minimum distributions from retirement accounts has risen to 72 years of age (from 70 ½).  The new law permits unlimited tax-free charitable contributions from your retirement accounts. Additionally, it allows for withdrawing $5,000 penalty-free to help cover the expenses of a new child (via birth or adoption).

However, the Secure Act will have the effect of preventing retirement plans from continuing to pass tax-free from generation to generation. According to the Congressional Research Service, the new law has the potential to generate about $15.7 billion in tax revenue over the next 10 years because of new restrictions put on the “Stretch IRA” strategy. Previously many individuals set up retirement funds with a trust as the beneficiary, allowing for the one who inherited to enjoy extended time to “stretch out” the tax benefits. Under the Secure Act, however, the rule is simple: all funds from such accounts must be taken out by the end of year 10 after the owner’s death. The elimination of the “stretch” option for non-spouse designated beneficiaries who inherit a retirement account[1] is significant for many clients with retirement accounts.

Under the SECURE Act, there are a few exceptions to the 10-year rule. Assets left to a surviving spouse are still eligible for a spousal roll-over. Disabled or chronically ill beneficiaries can similarly receive an inherited IRA and stretch out the retirement account for their lifetime; however, for the disabled or chronically ill person to qualify for this exception, their illness/disability must be present at the time of the plan owner’s death.  For disabled beneficiaries, this is actually a positive change because this was not the rule under the old law. Those who have already made plans with a special needs trust should meet with their attorney and have it revised to address this positive change in the law.

Another exception to the 10-year rule is Minor Children. However, minor children can only do the stretch-out until age 18 (or whatever the age of majority is in your state).  It is possible if they are in school the child might be able to do the stretch-out until age 26, but after that, the 10-year countdown starts. You must discuss what you want to do that this point. It can come out at the beginning of the 10-year period, in the end, or in installments – it is up to you to decide the best option for your child.  An example of yearly installments is a child inherits $1,000,000 in an IRA and it grows by 6% a year. Taking it out in yearly installments gives the child approximately $135,000 a year in extra income. If this starts at 18, it is hard to imagine what the money will be spent on absent supervision. Some children are very responsible, and others not so much. This is definitely a decision that should be made by the parents who know their children and their level of responsibility. (Although, things change when parents die.) 

The team at Dunlap Bennett & Ludwig includes very experienced estate planners who have children of their own. Between their work and personal experiences, they can guide you in thinking over all your options. The SECURE Act creates a new level of complication that should not be minimized or overlooked. 

What if your children are older (not minors), and the plan is just to name them outright on the beneficiary designation?  That is certainly possible, but again the tax consequences are significant. Using the same example as above, getting an extra $135,000 a year means a lot of extra tax to pay.   It is enough money to bump that child up one or two higher tax brackets unless they are already in the highest tax bracket. Unfortunately, if you want to leave the money to your grandchildren, they must take the money out within five years. Even if they are minors, the exception does not apply to them, which means the money will be paid to their estate or to a trust. That tax consequence is even worse. Estates and trusts are taxed at the highest tax rate. 

Most people work hard and saved in their retirement plans to help their loved ones, not to put them in a higher tax bracket. Unfortunately, the true goal of this new law is to get the money out of the retirement accounts and collect the tax.  However, DBL can work with you and offer some good strategies that can help defer the tax or replace income.  The following are some options:

Charitable Remainder Trust (CRT)

If there are charities that are important to you, a charitable remainder trust (CRT) might be an excellent solution for you. A CRT would allow you to name beneficiaries to receive an income stream from the retirement account for 20 years, with 10% of the value put in the trust at the beginning going to the charity of your choice. This has the effect of taking what would otherwise be a 10-year period or a 5-year period and changing it into a 20-year period.

Irrevocable Life Insurance Trust (ILIT)

Another option is to use funds from your retirement account to purchase additional life insurance and transfer ownership of the insurance policy to an ILIT. The ILIT can be used by your beneficiary to offset the tax hit incurred when the 10 years are up and all funds from the retirement accounts must be withdrawn and taxed.

Multi-Generational Spray Trust

Any number divided by a large number of results in a smaller number. This is true with distributions involving retirement accounts. While the distributions must be made within 10 years, by distributing the retirement account to multiple beneficiaries at the same time over the 10-year period, the required minimum distributions received by each beneficiary will be smaller, and the resulting tax liability per beneficiary will be reduced. For asset protection purposes, it is always advisable that the distributions be made to a trust for the benefit of a beneficiary instead of directly to the beneficiary.

Rhonda Miller

 

Rhonda A. Miller is a national partner at Dunlap Bennett & Ludwig. She runs our Estate Planning and Tax Department and is giving several national seminars on SECURE to include: Inherited IRAs: New Realities and Planning Opportunities” being held on 2/25/2020 for National Business Network.  She is also being filmed for IRA Planning after SECURE Act to be broadcasted on July 15, 2020 Rhonda A. Miller is a thought leader on the subject of the SECURE Act.  If you would like your current Trust reviewed or new estate planning to be done.  Please contact our office at 703.777.7319 or email estate@dbllawyers.com.

 

 

[1] If a beneficiary is not considered a designated beneficiary, distributions must be taken by the fifth year following the account owner’s death. Common examples of beneficiaries that are not designated beneficiaries are grandchildren, nieces and nephews and estates. See Treas. Reg. § 1.401(a)(9)-3, Q&A (4)(a)(2) and 1.401(a)(9)-5, Q&A (5)(b).

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