Just before the end of 2019, the “SECURE Act,” a bill that includes many changes to the federal tax code that apply to qualified retirement plans, such as a 401(k) or IRA, (“retirement assets”) was signed into law. The provisions of the SECURE Act, which became effective on January 1, 2020, are lengthy and complex. This Law Alert addresses one particular aspect of the SECURE Act: the impact on inherited retirement assets under estate plans. The SECURE Act has changed the timing and amount of income tax paid by many beneficiaries on distributions of retirement assets. As a result, the value of the benefit to the beneficiaries of an estate may be different from the pre-SECURE Act value. The following is a brief explanation.
Important Changes to the Payout Period for Beneficiaries (“The Stretch”)
- Pre-January 1, 2020
Until now, anyone could be named as the beneficiary of retirement plan assets and potentially, the beneficiary could receive distributions from the retirement assets over the beneficiary’s lifetime. This was referred to as “the stretch.” This was valuable for planning purposes, as retirement assets could continue to grow tax free, and the cumulative income taxes would likely be less as the retirement funds would be distributed to the beneficiary over time.
- Effective January 1, 2020
The SECURE Act has changed the rules, so that most beneficiaries will be now be required to take out all retirement assets within 10 years of the death of the person who funded the retirement plan or IRA. There are some exceptions:
- A surviving spouse;
- Minor children (but not grandchildren) of the decedent, and only until the age of majority, after which the 10-year rule applies;
- Beneficiaries who are disabled;
- Beneficiaries who are chronically ill; and
- Beneficiaries who are not more than 10 years younger than the decedent.
For beneficiaries who fall into any of these categories, the old rule applies and there is still the potential for a lifetime stretch.
Timing is Everything
Unfortunately, Congress gave little warning and thus, little time to prepare in advance – these changes were announced December 20, 2019 and went into effect on January 1, 2020. The new rules will apply to the estate of anyone who dies on or after January 1, 2020. Estate plans that, through the end of 2019, offered a sound approach to planning for retirement assets, may no longer provide a good solution. For example, an individual may have designated a “conduit trust” as beneficiary of his or her retirement assets. Any retirement assets paid to a conduit trust pass immediately from the trustee to the beneficiary. Under the old law, that may have been a good plan in some situations, because the distributions would be stretched over the expected lifetime of the trust beneficiary. However, under the SECURE Act, that same conduit trust may now require distribution of the retirement assets to the beneficiary within 10 years of the retirement asset owner’s death. Depending on the circumstances, other planning techniques, such as an “accumulation trust,” may serve better to protect retirement assets than what may be provided in an existing estate plan. This may be particularly the case when the beneficiaries are children.
Changes Affecting You During Your Lifetime
Not all the news is bad. Here is some information that will be helpful in designing an estate plan:
- The age for required minimum distributions (“RMDs”), has been changed to age 72. Under the old law, most people (with the exception of someone not yet retired), were required to begin taking distributions from their qualified plans or traditional (non-Roth) IRAs by April 1 of the year following the one in which they reached age 70½. Individuals for whom the old rule had already become applicable and who have already begun taking RMDs, however, must continue to receive RMDs even if they have not reached age 72.
- The age cap for funding traditional IRAs has been eliminated, so that individuals who are over age 70½ are now eligible to make contributions to a traditional IRA.
- Contributions made from certain retirement assets to a qualified charity, called Qualified Charitable Distributions (“QCDs”), may still be made upon reaching age 70½, even if RMDs have not commenced.
Note: The plan participant’s own required payout period, referred to above as the stretch, is not affected by the SECURE Act. The SECURE Act changes to the required payout period only apply to beneficiaries under an estate plan who inherit the retirement assets from the plan participant.
This Law Alert is a brief summary of some of the major points of the SECURE Act that may affect estate plans. This is the first new law on federal retirement benefits in decades, and there will be much more discussion and deliberation as questions and comments emerge. This is an excellent opportunity to consider reviewing your estate plan, both the estate planning documents (will and trust), and the means of funding (beneficiary designation forms). To have a complete picture, not only must the estate plan documents be reviewed, but also the beneficiary forms need to be carefully examined to be sure that they reflect your wishes and that the administrator of the plan confirms that they have been accepted and recorded.
Please contact Regina Snow Mandl if you’d like a more detailed explanation of the significance of these changes, how they might affect your estate plan, and to assist with any revisions that might be necessary to protect your beneficiaries and their inheritance of your retirement assets.