The Setting Every Community Up for Retirement Enhancement (SECURE) Act, which became effective earlier this year, has made many changes to longstanding retirement rules. As a result, many clients have contacted our office recently with questions regarding how the Act affects their estate planning, if at all. Below is a brief summary of the changes most likely to affect you:
- Repeal of Age Restrictions for Traditional IRA Contributions:
The old law prevented anyone older than 70 ½ from making contributions to their traditional IRA; however, the new law allows taxpayers to make contributions to their traditional IRA at any age provided they are working and their contributions come from earned income. This does not affect Roth IRAs as taxpayers were already able to contribute to them at any age.
- Age Required to Begin Required Minimum Distributions (RMDs) Increased to 72:
Under the old law, taxpayers typically needed to begin taking RMDs from their traditional IRA or 401(k) by April 1 of the calendar year following the calendar year in which they turned 70 ½. The new law extends this deadline to 72 for those born after June 30, 1949.
- Changes to Inherited Retirement Account Withdrawals:
A common estate planning technique under the old rules, known as a stretch IRA, was to stretch withdrawals from inherited retirement accounts over the beneficiary’s lifetime. This allowed the assets to continue appreciating in value while reducing annual income tax obligations. The new law eliminates this technique except for those who qualify as “eligible designated beneficiaries.”
Eligible designated beneficiaries include the following:
- Surviving spouses
- Chronically ill or disabled beneficiaries
- Minor children up to the age of majority (not grandchildren)
- Individuals not more than 10 years younger than the IRA owner (this would apply to many siblings)
Unless you qualify as an eligible designated beneficiary, the new law requires individuals to withdraw the balance of the inherited retirement account within 10 years from the date of the owner’s death. Although you can wait to withdraw anything until the end of the ten-year period, you may face a high tax bill should you decide to do so. It is important to note, however, that the old rules still apply to individuals who inherited retirement accounts prior to 2020.
- Additional Miscellaneous Provisions:
1. The new rules allow for penalty-free withdrawals from 401(k)s and IRAs in amounts not to exceed $5,000 for qualifying childbirth and adoption expenses incurred within one year of the birth or adoption.
2. Advantageous tax treatment under 529 Plans for qualified tuition programs have been expanded to include fees, books, supplies, and equipment required for certain apprenticeship programs. Additionally, up to $10,000 may be used to pay for principal or interest on qualified educational loans.
3. Although taxpayers do not need to begin taking RMDs until they turn 72, they may still, beginning at age 70 ½, make distributions of up to $100,000 annually from their traditional IRA directly to charity without needing to recognize said distributions as income.
- How do these Changes Affect my Existing Estate Plan?
The SECURE Act has forced many people to reevaluate their estate planning. Whereas many people previously named a Trust as the beneficiary of their retirement accounts in order to retain some control over how and when the money would be distributed after their death, this may not be the best option due to the money needing to either be distributed within 10 years or be subject to the high tax brackets applicable to Trusts, which quickly max out at 37%.
Although a Trust may still use the stretch method for eligible designated beneficiaries, this option disappears the moment the beneficiaries cease to be eligible (e.g., when a minor child reaches the age of majority.) At that point, the 10-year rule applies.
To our clients for whom we have prepared a Testamentary or a Revocable Trust which is named as beneficiary of a retirement account, we recommend you review the beneficiary designations for your retirement accounts and the terms of the Trust in this regard. Contact us with any questions.
We recognize the SECURE Act is confusing and may have presented you with many questions regarding how to best prepare or whether you need to reevaluate your estate plan.