The Setting Every Community Up for Retirement Enhancement Act (SECURE Act) was signed into law on December 20, 2019, with significant changes to IRAs, Roth IRAs and qualified retirement plans (401(k), 403(b), government 457 plans, etc.). While there are many changes involved with this new tax law, below is a summary of the main provisions related to distributions from IRAs and retirement plans. With provisions being effective at the beginning of this year, now is the time to consider how these rules effect your tax, retirement and estate planning situation.
Age increased for required minimum distributions.
Under prior law, you had to start taking required minimum distributions (RMDs) from your traditional IRA when you turned age 70.5. The same rule applies to retirement plans if you’re a 5 percent or more owner, even if you’re still working. Under the new law, though, if you turn age 70.5 in 2020 or later, your RMDs don’t start until age 72. You have until April 1 of the following year to take your first RMD. The old rules still apply to those who turned age 70.5 prior to 2020. If you are less than a 5 percent owner of the company, haven’t retired, and the employer plan allows you to delay RMDs, you don’t need to start RMDs until you retire.
Post-death distributions.
For those inheriting IRAs, Roth IRAs and qualified retirement plans before 2020, distributions are taken over the life expectancy of the designated beneficiary if that’s an individual or a qualified trust. If children or grandchildren inherited a retirement account, they were able to stretch those RMDs over their long-life expectancies. The distributions would be small, leaving the larger balance to grow tax-deferred for many years.
The biggest change under the new law is the severe shortening of the stretch for these accounts. For deaths of account owners after 2019, beneficiaries must fully distribute the inherited account by the end of the 10th calendar year following the account owner’s death. This new rule doesn’t apply to certain designated beneficiaries (now called eligible designated beneficiaries), including 1) the spouse, 2) a minor child, 3) a disabled or chronically-ill person, or 4) a person not more than 10 years younger than the account owner. A minor child becomes subject to the 10-year rule starting at the age of majority (age 18 in New York), so the account would be fully distributed before they turn age 29.
Trusts that are structured a certain way are often named as beneficiary of an IRA or retirement account, perhaps to minimize state estate taxes (i.e. New York estate tax) if it was the main asset in the estate. Or, perhaps to protect the account from the beneficiary depleting it faster than the RMDs. The trust might be designed to flow distributions right out to the trust beneficiary for tax and cash flow reasons or it might be designed to accumulate most of the distribution in the trust. The 10-year rule also applies to trusts inheriting IRA or qualified plan accounts starting in 2020, which means significantly larger distributions to either the beneficiary or the trust. The accelerated distributions to the beneficiary are exposed to creditors and divorcing spouses.
This accelerated distribution period has significant income tax and financial implications that need urgent attention and careful planning. The larger distributions, whether spread over 10 years or taken lump-sum in the 10th year, would result in significantly more taxes for IRAs and qualified retirement accounts. Consider a $2M IRA account. Distributions would be $200k annually if distributed evenly over the period or $2M all in year 10 if distributed lump sum. Not only will that result in high taxes, but that is a lot of money coming out to the beneficiary, possibly at too early an age. Roth IRAs fall under the same rules. Even though the distributions aren’t taxable to the beneficiary and the beneficiary should delay distributions until the 10th year, cash will be coming out much quicker under the new law.
In short, the SECURE Act completely shakes things up. The implications will be different for everyone and should be viewed holistically. You may need to revamp your current estate plan to avoid any undesirable results, and you may want to reconsider who your beneficiaries are on retirement accounts, what the structure of trusts formed in your will or revocable trust are, how you satisfy charitable inclinations and who should inherit which assets and how. Any existing trusts should be re-examined to see if they can and should be modified. Roth IRA conversions should be evaluated in the context of the rest of your financial and tax situation like usual, but also in light of the law change. Lastly, this adds further considerations to the decisions on whether to contribute to a Roth IRA or Roth 401(k) over traditional accounts in your accumulation years.
Don’t delay in gaining an understanding of how the SECURE Act affects your tax, retirement, and estate plans and what changes, if any, need to be made. Reach out to our Bonadio team today to learn more.