On January 1, 2020, the new SECURE Act became effective. The SECURE Act (which stands for Setting Every Community Up for Retirement Enhancement Act) is the most significant retirement reform to take place in more than a decade. This Act arose as a response to the improving life expectancy and an increased number of individuals working in their 70's.
What Has Changed?
IRAs. The SECURE Act eliminates the age cap for contributing to traditional IRAs. It also increases the age when individuals are required to take minimum distributions (or RMDs) from 70 ½ to 72 for people born after June 30, 1949. This allows individuals an additional 1.5 years of tax-deferred saving.
401(k) Plans. The SECURE Act includes provisions that make 401(k) plans more accessible to small businesses, and even allow certain long-term part-time workers to participate in 401(k) plans. The Act also includes a provision for new parents to make penalty-free withdrawals (under certain restrictions).
Inherited IRAs. One of the most significant changes by the SECURE Act is requiring the full-distribution of inherited IRAs (and Roth IRAs) by the end of the 10th year of the account owner’s death. This change eliminates the planning strategy called the “Stretch IRA”. With this strategy, a non-spouse IRA (or Roth IRA) beneficiary would “stretch” the distribution of an inherited IRA over his or her fixed life expectancy. The benefit of this strategy was two-fold: beneficiaries could minimize the amount of taxable income from taking distributions while allowing remaining funds to continue compounding tax deferred within the IRA. However, with the new SECURE Act in place, beneficiaries will no longer be able to use this strategy. It is anticipated that the 10-year limit will push larger RMDs into the highest income years and, thus, the highest tax years of a beneficiary’s life. Congress expects that this change will raise nearly $16 billion in tax revenue, which will fund many of the other changes made by the Act.
Who is Affected?
The new 10-year limitation on inherited IRAs will apply to IRA (and Roth IRA) beneficiaries where the account holder dies on or after January 1, 2020. Beneficiaries who are already taking advantage of the “Stretch IRA” strategy will not be subject to this new limitation (if the account holder died in 2019 or earlier). However, if the named beneficiary dies before the complete distribution of the account, subsequent beneficiaries will be subject to the 10-year limitation.
Included among those affected are individuals who are the beneficiaries of a “see-through” or conduit trust. If a conduit trust is named as beneficiary, a full payout of the account must occur within 10 years to the beneficiary. If you do not intend the beneficiary to have access to the IRA funds so soon, then you should reconsider naming a conduit trust as beneficiary.
Those not affected by this new legislation include a beneficiary who is a surviving spouse, minor child (but not grandchild), disabled or chronically ill individual, or an individual who is no more than 10 years younger than the account holder. For minor children, the 10-year limitation will apply once the child reaches age 18. For all others, the 10-year limitation will not apply and those beneficiaries can continue taking distributions over their life expectancy.
With all the changes the SECURE Act brings, it would be a good idea to sit down and review your estate and retirement plans. New legislation requires new strategies to minimize tax liability. For example, married couples usually name their spouse as primary beneficiary and children as contingent beneficiaries. However, with this new legislation, it may make more sense for the primary to be split between your spouse and children. The children can start taking smaller distributions at the death of the first parent and then start the second half at the death of the second parent. This will allow your children to stretch their distribution for up to twice as long and pay less in taxes.
New strategies like these and others may result in what is best for you and your family. Meet with your financial and legal advisors to make sure you are planning well for the future.
Source: The SECURE Act of 2019 by Bond Schoeneck & King PLLC