How Secure Is Your Retirement Plan After the SECURE Act?
On December 20, 2019 the SECURE (Setting Every Community Up for Retirement Enhancement) Act was enacted into law. The Act includes minor changes to the law in several areas, along with some significant changes regarding the distribution of certain retirement plans following the death of the owner. Highlights (or lowlights) of the Act follow:
The Act applies to owners of qualified retirement plans such as IRAs and 401(k)s who die after December 31, 2019 (for purposes of this post all such qualified plans are referred to as IRAs for simplicity). Several changes can be viewed positively for plan participants and their beneficiaries. Examples include:
- The age at which an IRA owner must begin to withdraw from the plan is increased from 70 1/2 to age 72 (Required Beginning Date or RBD).
- Individuals can contribute to IRAs beyond the RBD if the plan owner is working.
- Employers will be permitted to allow (and in some cases required to provide information about) converting existing plans into lifetime annuity streams.
- Plan owners may withdraw $5,000 within one year of the birth or adoption of a child without any penalty.
- 529 plans may be used for certain registered apprenticeship programs and to pay up to a maximum of $10,000 toward student loans.
The changes of the Act which will have the greatest impact, however, have to do with the period of time over which a beneficiary may withdraw the assets of an inherited IRA. Previously, a designated beneficiary (DB) (e.g., an individual or a trust for an identifiable individual) could withdraw the inherited IRA over his or her life expectancy determined at the time of the IRA owner's death. Under the Act (which supplements existing law) there are now three possible categories of beneficiaries:
- No Designated Beneficiary. If there is no beneficiary, or if the beneficiary is an estate, charity or a trust without qualifying designated beneficiaries, all inherited IRA assets must be withdrawn by December 31 of the year including the fifth anniversary of the IRA owner's death. This is not a change from existing law.
- Designated Beneficiary. If there is a DB, the general rule now requires all assets in the inherited IRA to be withdrawn by December 31 of the year including the 10th anniversary of the IRA owner's death. The consequences of this new rule are demonstrated by the following examples:
- Under the prior law, a 45-year old whose parent died on December 31, 2019 would be entitled to a life expectancy distribution schedule over roughly 38 years or by 2057 (with pre-determined fractional distributions required annually).
- Under the Act, if the parent died on January 1, 2020 the beneficiary would be required to withdraw all of the assets in the inherited IRA no later than December 31, 2030.
- If the same 45-year old whose parent died on January 1, 2020 was the beneficiary of a trust established in 2019 and designed to receive the minimum required distributions from the IRA and subsequently distribute those distributions over the beneficiary's life expectancy in an effort to control the amount withdrawn from the IRA and received by the beneficiary, that same trust will now require the entire IRA to be distributed to the trust and then to the beneficiary no later than December 31, 2030. If the beneficiary is unable to manage money or has a substance abuse problem, the results could be disastrous.
- Eligible Designated Beneficiary. There are several exceptions to the 10-year payout rule in which a beneficiary may still use a modified life expectancy distribution. The eligible beneficiaries in this regard are:
- A surviving spouse
- A minor child (until the age of majority)
- Disabled and chronically ill beneficiaries
- A beneficiary who is less than 10 years younger than the plan owner
Although these beneficiaries will qualify for a life expectancy payout period, upon the death of any such beneficiary (or the attainment of age of majority by a minor) the 10-year payout period described above will apply.
Anyone who owns an IRA (or other qualified plan) will be affected by these new rules. For some, the change in rules will not cause them to change their estate plan. However, in many cases, particularly involving IRAs of significant value and situations involving IRAs that name certain types of trusts (such as conduit trusts which require all IRA distributions received by the trust to be distributed to a beneficiary), the consequences could be significant.
IRA planning has traditionally focused on achieving the longest possible payout period. Being required to withdraw the assets from an IRA decades faster than prior law will result in significantly increased income tax liability for IRA beneficiaries. While this result may not be avoidable now, it may be possible to engage in other planning to minimize the effects of the result. In addition, beneficiaries who were intended to only receive piecemeal distributions over their lifetime (because of inability to manage money, substance abuse problems, concerns about spouses, etc.) will in many cases receive an inherited IRA in just 10 years.
If you have concerns about your IRA or other qualified retirement plan, the estate planning attorneys at Varnum can help.
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- Estate Planning Advisory, December 20, 2019
- Estate Planning Advisory, November 11, 2019
- Estate Planning Insights, September 9, 2019