On December 20, 2019, President Trump signed into law the SECURE Act (Setting Every Community Up for Retirement Enhancement), which was included in a last-minute appropriations bill designed to avert a government shutdown before the end of the year.
The new law will now affect how individuals are able to save money for their retirement, and how heirs will eventually be able to use those funds once the account holder has passed away.
Key changes under the SECURE Act include the following (keep reading or watch our educational video here):
New Age Requirements for RMDs
The SECURE Act will allow those who work past age 70.5 to contribute to IRAs, now matching the rules for 401(k)s and Roth IRAs. The bill also pushes back the date to start Required Minimum Distributions (RMDs) to age 72 for those who did not reach age 70.5 by the end of 2019. This specific change will lower the amount of money that seniors will need to withdraw each year during their retirement. For many this will be the biggest benefit.
Beneficiaries Can No Longer Choose to “Stretch” an Inherited IRA
Now for the bad news. Under the SECURE Act, younger beneficiaries can no longer “stretch” their IRA. This was a process by which a beneficiary would take small required minimum distributions over his or her lifetime, while “stretching” the tax-deferred growth of the IRA over decades. IRA funds passed to beneficiaries, other than a spouse, will now have to be withdrawn within 10 years of the death of the original holder and would be subject to taxes much sooner than heirs may have been expecting. The net result of accelerated taxes will mean potentially higher personal tax brackets for beneficiaries and diminished value resulting in your beneficiaries receiving less than the the Participant intended.
To be clear, not all beneficiaries are created equal and not all will face the 10-year rule. In those exceptional situations, the old rules continue to apply. These eligible designated beneficiaries are:
- The spouse of the plan Participant –
- A child of the Participant under the age of majority (typically 18) – There are two caveats here. First, it must be a child of the Participant, not just any minor child. Second, once the child reaches the age of majority, the 10-year rule applies at that time.
- A person who is medically disabled or chronically ill.
- A person who is less than 10 years younger than the Participant.
What’s the impact to you and your beneficiaries?
Your beneficiaries will not get as much of an income tax deferral as in the past. This means your beneficiaries will be required to pay the income tax due on the assets (if any) faster than in the past. It doesn’t necessarily increase the tax they’ll owe, but it means they’ll owe it sooner. However, the accelerated withdrawal may push them into higher tax brackets which will increase their overall taxes and thus diminish the value of the retirement accounts you intend to leave them for their benefit.
If you already inherited a retirement account from a spouse, parent, or another person who died before January 1, 2020, then do not worry as the old rules continue to apply to you. Just be mindful that the new rules will apply to the beneficiaries you’ve designated on that inherited retirement account and may subject them to the Ten-Year Rule. That includes you, too. If you are a future beneficiary of a parent or another person’s retirement account (other than your spouse), you might be inheriting more of a tax problem than a benefit.
Beneficiary Designations Should Be Reviewed
With the changes to the laws surrounding retirement accounts, now is a great time to review and confirm your retirement account information. Whichever estate planning strategy is appropriate for you, it is important that your beneficiary designation is filled out correctly. If your intention is for the retirement account to go into a trust for a beneficiary, the trust must be properly named as the primary beneficiary. If you want the primary beneficiary to be an individual, he or she must be named. Ensure you have listed contingent beneficiaries as well.
If you have recently divorced or married, you will need to ensure the appropriate changes are made because at your death, in many cases, the plan administrator will distribute the account funds to the beneficiary listed, regardless of your relationship with the beneficiary or what your ultimate wishes might have been.
Explore Options to Minimize Tax Consequences for Beneficiaries
It is a common myth that an inheritance cannot be taxed. Indeed, there are still a few states that impose an inheritance tax. But even in other states without an inheritance tax, the fact remains that taxes are a certainty in life as much as death and change. The SECURE Act brings this reality to the forefront even more when it comes to the income taxes of your beneficiaries. As discussed above, the bad news is that Ten-Year Rule may increase income tax for our beneficiaries. You will want to discuss possible solutions with both your financial advisor and estate planning attorney as many solutions will require integrated solutions.
Consider Other Trusts
For most Americans, a retirement account is the largest asset they will own when they pass away. If we have not done so already, it may be beneficial to create a trust to handle just your retirement accounts. While many accounts offer simple beneficiary designation forms that allow you to name an individual or charity to receive funds when you pass away, this form alone does not take into consideration your estate planning goals and the unique circumstances of your beneficiary. Whether your utilizing irrevocable life insurance trusts, charitable remainder trust planning, or to standalone retirement trusts (also called “IRA Trusts”), the good news is that a trust is a great tool to address the mandatory ten-year withdrawal rule under the new Act and to provide continued protection of a beneficiary’s inheritance.
Trusts Dealing with Retirement Accounts May Need to Be Updated
For those who have trusts in place already, whether they are revocable trusts or standalone retirement trusts, the SECURE Act may require that your trust be updated in 2020. Planning strategies that were developed and used for years before the passage of the SECURE Act could now result in unexpected tax consequences and even significant tax hikes for heirs. It may be necessary to look at alternative planning strategies in light of these changes. More generally, the language in many trusts will need to be updated in order to be compliant with the new laws. Again, if this is not done, existing trust language could unintentionally restrict access to your beneficiaries’ funds and cause major tax headaches.
How Do I Know If My Plan Needs to Change or I Need a New Solution?
Although this new law may be changing the way we think about retirement accounts, we are here and prepared to help you properly plan for your family and protect your hard-earned retirement accounts. Because each retirement account and estate plan is different, it’s a wise idea to have your documents reviewed to ensure that they will still accomplish your goals under the new laws. If you live in the state of California, we invite you to call our Orange County law firm at (949) 333-3702 to schedule a 15 minute phone call to find out more about how we can review your current documents and help you achieve the peace of mind knowing that your plan will still work as intended and be helpful to your loved ones rather than a burden.
Do You Have Any Questions?
Kevin Snyder is a husband, father, and an Orange County estate planning attorney at Snyder Law, PC in Irvine, California. He’s all about family and passionate about estate planning, elder law, and veterans. He founded Snyder Law to help families from Orange County, Los Angeles County, and Southern California plan to protect what matters most: their loved ones, their dignity, and their legacy.