The Setting Every Community Up for Retirement Enhancement Act of 2019 (The Secure Act) was passed by Congress on December 19, 2019 and signed into law the following day by President Trump. The stated public policy behind the new law is to encourage individual retirement savings. This is the biggest legislative change to the retirement system since the Pension Protection Act passed in 2006. Among other changes to the existing retirement rules, the Secure Act eliminates “stretch” IRA provisions, modifies the rules for IRA contributions, increases the age for Required Minimum Distributions (RMDs) and expands the use of 529 plans.
Modifications to Required Minimum Distribution Rules
Prior to the Secure Act, non-spouse IRA beneficiaries were permitted to “stretch” RMDs from inherited retirement accounts over the course of their own lifetimes. The stretch IRA was a great planning tool because it allowed beneficiaries to spread out their tax burden over their lifetimes. Thus, beneficiaries of inherited IRAs could leave assets (beyond the RMD payments) in retirement accounts, allowing them to continue to grow tax-deferred and withdraw a larger percentage of the assets post-retirement, typically while subject to a lower tax bracket.
As of December 31, 2019, the Secure Act eliminates this potential stretch for most inherited accounts and instead requires that the assets be withdrawn within 10 years following the death of the account holder. As a result of the stretch elimination, more individuals will be forced to collect larger amounts while still working, potentially exposing them to a higher tax rate. The stated public policy behind the end of the stretch IRA is that inherited accounts are not “retirement accounts;” therefore, they should not be treated as such in the hands of the inheriting beneficiary.
Surviving spouses will be exempt from the 10-year rule and can continue to roll IRA assets received from a deceased spouse directly into his or her own IRA, where normal rules apply. An exemption also exists for accounts left to minor children (the 10-year period will begin once they reach the age of majority or 26 if they are still in school), disabled or chronically-ill beneficiaries and beneficiaries who are less than 10 years younger than the account holder.
Repeal of Maximum Age for Traditional IRA Contributions
The Secure Act repealed the prohibition on contributions to a traditional IRA by an individual who is 70½ years old. Individuals are living longer and working much later into their lives so this change is intended to enable workers to contribute to a traditional IRA if they continue to work past age 70. Under the new law, taxpayers may contribute to traditional IRAs as long as they are still working. IRAs will now follow the same rules that already apply to 401(k) plans and Roth IRAs, neither of which have a maximum contribution age.
Increase in Age for Required Beginning Date for Mandatory Distributions
Before the implementation of the Secure Act, account owners were required to begin taking distributions from their retirement plans at age 70½, to ensure that individuals spent their retirement savings during their lifetimes. Along with the repeal of the maximum contribution age, the Secure Act takes into account longer life expectancies by delaying required minimum distributions to age 72, giving participants an additional 18 months to defer tax.
Expansion of Section 529 Plans
The Secure Act allows 529 college savings plans to be used for qualified student loan repayments up to $10,000. The $10,000 limit is a lifetime limit per beneficiary. Under the new law, principal and interest payments towards qualified education loans are now considered qualified 529 plan expenses.
Planning Under the Secure Act
Many of the Secure Act’s changes will have only a minor impact on most individuals’ savings for retirement, but a few of the statute’s provisions, such as the elimination of the stretch rule for inherited IRAs in particular, will directly affect financial and estate planning opportunities for large account owners and their families. Such individuals will need to closely review their tax-planning strategies pertaining to inherited IRA accounts.
No planning changes will be necessary for beneficiaries who intend to withdraw all of the funds within 10 years of inheriting an IRA account. In fact, the Secure Act helps these beneficiaries by eliminating all RMDs for the 10 years following an account holder’s death. Beneficiaries can maximize the tax-deferred growth of these funds by allowing the funds to grow tax-free for 10 years and then withdrawing them in a lump sum in year 10.
On the other hand, beneficiaries who do not have near-term needs for such inherited IRA holdings are disadvantaged by the Secure Act. Due to the new 10-year withdrawal rule, some beneficiaries will receive and be taxed on these assets earlier than they prefer. This is especially unfortunate for individuals in their peak earning years at the time of distribution since they are likely categorized in higher tax brackets than they will be later in life. Beneficiaries can attempt to mitigate some of this tax-disadvantaged situation by planning to take withdrawals from the IRA in the year, or years, over the 10-year period that they expect to have the lowest income.
Account owners can also take steps to reduce the negative impact of the Secure Act on their long-term planning. Among other planning options, large account owners should consider the following opportunities:
- Leave the IRA to an individual who still qualifies under one of the Secure Act’s exclusions for life expectancy payout. In the case of an account owner with a surviving spouse, this is often the default, but as mentioned, the exclusions also apply to other individuals. The account owner may wish to shift some or all of the assets in the account to a beneficiary who will not be subject to the 10-year rule. For example, if an account owner has a grandchild who qualifies as disabled or chronically ill under the Secure Act, she may wish to name that individual as the beneficiary of some or all of the IRA assets (and possibly make an equalizing distribution to other beneficiaries under her will).
- Alternatively, charitably-minded account owners may instead wish to leave the IRA to a charitable remainder trust (CRT). A CRT is a trust under which named individual beneficiaries receive trust payments for a period of years, and at the end of the trust term, the balance of the assets is contributed to one or more charities. This approach can significantly reduce the income tax on the IRA itself and provide a lifetime payout to beneficiaries that will replace some of the lost life expectancy payout they would have received from an RMD. Under this approach, human beneficiaries are unlikely to receive more than they would have had they inherited the IRA directly due to substantial amounts being paid to charity. Therefore, this plan may only be attractive to account owners with strong philanthropic interests. Philanthropically-inclined individuals who do not currently plan to leave their IRAs to charity may now have more motivation to make this change. Leaving a retirement account to charity has a double benefit of avoiding both estate and income taxes on the value of the account and may be a more popular option in light of elimination of the stretch provisions.
- Account owners who are in lower tax brackets than their expected beneficiaries may consider doing a Roth conversion during their lifetimes. Assets converted from a traditional IRA to a Roth IRA will be subject to income tax (at the account owner’s rate) at the time of conversion, thus paying tax at a lower rate than would apply to future beneficiaries. All future distributions from the Roth IRA will pass tax-free to its beneficiaries. Although Roth conversions are not always attractive options (depending on a number of factors, including whether the owner has sufficient funds outside of the account to pay the taxes), they are worth exploring in some situations.
- Account owners could also consider accelerating RMDs (and unfortunately the associated tax) to fund an irrevocable life insurance trust (ILIT). Upon the death of the insured, the life insurance policy will remain in the ILIT, which has no RMDs, will not be subject to estate tax and can be distributed under the terms selected by the grantor.
- Finally, account owners who name trusts as the beneficiaries of their IRAs should explore whether the named trusts are still appropriate vehicles for these distributions. There are two types of trusts that can be used as beneficiaries of IRA accounts: accumulation trusts and conduit trusts. Accumulation trusts can hold plan distributions and distribute them over time in accordance with the terms of the trust. Conduit trusts are designed to take advantage of the now-defunct stretch rule by passing IRA distributions directly through to beneficiaries when they are received by the trust. Under the Secure Act, the IRA account will still need to distribute all its assets to the trust within 10 years of an account owner’s death. However, because distributions automatically pass through conduit trusts into the hands of beneficiaries, the non-tax benefits of trusts (including creditor protection and established distribution terms) are eliminated. In most instances, account owners who previously named conduit trusts as the IRA beneficiaries will want to consider revising their plans to include accumulation trusts instead.
If you would like to discuss the implication of the Secure Act on your personal IRA account(s), we encourage you to reach out to your Brown Brothers Harriman relationship manager.
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