The SECURE Act was passed late last year and includes sweeping changes to retirement plans, requiring many people to review—and possibly change—their beneficiary designations and/or estate plans. This column addresses general estate planning topics and is not meant as actual legal advice.
1. What is the SECURE Act?
The Setting Every Community Up for Retirement Enhancement Act—or “SECURE Act”—is a new law that was enacted on December 20, 2019, taking effect on January 1, 2020. It includes major changes for individuals with retirement plans (such as IRAs, 401Ks, and 403Bs), as well as several changes to the way employer-sponsored plans are administered. To pay for the new law, which calls for over $1.7 trillion of spending, the law effectively eliminates the “Stretch IRA” and accelerates distributions of tax-deferred retirement plans after the death of the plan participant.
2. What led to the passage of the SECURE Act late last year?
The SECURE Act was a bipartisan effort to address the growing concern that too many Americans are not saving enough for retirement. One in three Americans has less than $5,000 in retirement savings, and the median household retirement savings is only $50,000. Congress’s goal was to provide incentives and make it easier for businesses to offer retirement plans to their employees, as well as to allow more people to participate in tax-advantaged retirement plans and for longer periods of time.
3. How does this law encourage people to save more for retirement?
Certain part-time employees are now allowed to participate in employer-sponsored retirement plans. Although not every part-timer will be able—or can afford—to take advantage of this, it will certainly be helpful for people who have multiple part-time jobs, people just entering the workforce, or those who are scaling back hours as they near retirement.
Additionally, it is not uncommon to delay retirement and continue working well into your 70s. Before the SECURE Act, individuals were prohibited from making retirement plan contributions past the age of 70½. Now, there is no age limit on contributions to a Traditional IRA, allowing more time to save and invest on a pre-tax basis.
The law also delays depletion of retirement accounts. Historically, retirement plan participants were required to take minimum distributions each year starting at age 70½. The SECURE Act increases that start date to age 72, allowing retirement accounts to keep growing and deferring taxable distributions for a little while longer.
4. The new law regarding inherited IRAs requires payout within 10 years. What does this mean?
If a retirement plan participant dies in 2020 or later, the general rule is that the retirement account must distribute to the beneficiary over the course of 10 years. Previously, the beneficiary had the choice of “stretching” the distributions over his or her life expectancy. This was called the “Stretch IRA” and it was commonly used because retirement plan distributions are considered ordinary income and stretching out distributions over a long period of time was a tax advantageous way of inheriting a retirement account. In addition, it provided a nest egg for the beneficiary’s own retirement.
The Stretch IRA is now effectively gone and replaced with the 10-year payout rule. However, there are some exceptions and special rules if the beneficiary is a spouse, minor child, disabled person, or close in age to the plan participant.
5. Is there anything different I should be doing if my spouse is the outright beneficiary of my retirement plan?
Not really. Importantly, if a spouse is the beneficiary, the 10-year payout rule does not apply. The spouse still has the choice to either roll the account into his or her own IRA, or treat it as an inherited IRA and stretch the distributions over his or her life expectancy.
If your estate plan sets up a marital trust for your spouse and the trust is the beneficiary of your retirement plan, this arrangement should continue to work well as long as the trust was set up correctly in the first place. Many of my clients have this type of trust, most commonly when the client wants to make sure that his or her retirement plan is available for his or her surviving spouse, while ensuring that at the death of the surviving spouse, the retirement plan gets passed to the client’s children, instead of to a new spouse or to the children of the surviving spouse’s first or later marriage; or to prevent the spouse from succumbing to undue influence or unwise decisions later in life.
6. What if my children are named as beneficiary of my retirement plan?
If you have adult children who are named as direct beneficiaries, there is probably nothing you need to do except simply to understand that the taxes will be accelerated and there needs to be money available to pay the tax.
If you have minor children who are named as direct beneficiaries, the 10-year payout rule does not apply while the child is still a minor. During that time, the minor child (or more likely the guardian or custodian) will have to take required minimum distributions over the child’s life expectancy. Once the child reaches the age of majority, the account must be liquidated over the next 10 years, either in one lump sum or as desired over the 10-year period. This can be a problem for parents who do not want their retirement plans paid out to children or young adults. This is why many parents set up trusts for their children in their estate planning documents.
7. How does this affect the trusts that are set up in my estate planning documents?
If your will or revocable trust establishes trusts for your spouse, children, or other heirs, you should meet with your estate planning attorney to review whether those trusts will still have the intended effect. Some trusts will continue to work well, such as marital trusts for a surviving spouse. Other trusts will not work quite as intended.
If you have a “conduit trust” set up for your children, this means that any distributions from retirement plans paid to the trust must be subsequently paid out directly to the child in the same year. This type of trust will continue to work just fine, but since the 10-year payout rule applies, the distributions will simply flow from the retirement account, through the trust, and directly to the child within a 10-year period, rather than over the lifetime of your child, as you probably intended when you first set up the trust. There are still some valid uses of these trusts, but if you are concerned about the beneficiary having access to the distributions and spending unwisely, you may want to consider an accumulation trust, if you are willing to accept the adverse tax consequences.
An “accumulation trust” is designed to hold retirement plan distributions inside the trust, rather than pay them directly to the beneficiary. A reason for having this type of trust might be because you would rather keep the bulk of the retirement plan distributions inside the trust where they are protected from a child’s potential frivolous spending, creditors, divorces, or estate tax. Again, there is still some value to this type of trust, but it may not work as well as expected, because with the distributions taking place over a 10-year period, the taxation is accelerated. An accumulation trust pays taxes on any income not distributed to the beneficiary, and trust tax rates are generally higher than they are for many individuals. So it is important to review your trust in light of the new distribution rules and decide whether it is more important to protect the assets or to minimize taxes.
8. Is there anything else I could be doing?
If you are in a lower tax bracket than your beneficiary, or if you would rather take on the tax burden yourself than pass it to your beneficiaries, then you could consider converting your retirement plan to a Roth IRA.
If you want to leave money to a charity at your death, kudos to you! In addition to doing good, you are saving taxes. One way to do this is to leave your retirement plans to charity (because charities do not pay taxes on retirement plan distributions) and leave different assets to your other heirs. Another option is a charitable remainder trust in which your heirs get an income stream, and the balance goes to charity upon the heir’s death.
9. Review your estate plan now
The SECURE Act includes many important benefits for retirement plan participants but can make things complicated after the participant’s death. I would strongly advise business owners and professionals to meet with their estate planning attorneys to review their estate plans and beneficiary designations in light of the changes to post-death distribution rules.