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How will the SECURE Act Impact You?

Make the most of the opportunities provided by the SECURE Act to maximize your legacy.

How will the SECURE Act Impact You?

For many families, retirement accounts are the cornerstone on which their retirement plan is built. Whether an employer-sponsored 401k, a traditional IRA, or any number of other available options, the benefit of present income tax deferral (or tax-free growth in the case of Roth accounts) has encouraged many to diligently prioritize the funding of their retirement.

Retirement accounts have also provided significant estate planning opportunities. When appropriate beneficiary designations are made, retirement accounts are considered non-probate assets. As a result, title to the account should automatically pass to the designated beneficiary without the need for judicial involvement or a court-appointed personal representative. On top of this, a recipient inheriting a retirement account was historically able to use the recipient’s life expectancy to further stretch the distribution period for the account and maximize the benefits of tax deferral or tax-free growth.

Enter the SECURE Act. Effective January 1, 2020, the SECURE Act has significantly changed the retirement planning landscape. Under the new law, the “stretch” period for many beneficiaries is no longer based upon the beneficiary’s life expectancy. There are no longer RMDs or “required minimum distributions” for such beneficiaries. Under the SECURE Act, retirement assets now must be fully paid out to most beneficiaries within 10 years. As a result, clients should review their retirement accounts to determine whether further planning techniques should be employed and whether their existing estate plan will function as anticipated.

The 10-year Distribution Rule and Eligible Designated Beneficiaries

While the new 10-year distribution rule is a significant change from past practice, there are five exceptions that will lessen its impact for many families. Specifically, the life expectancy payout will remain intact for “eligible designated beneficiaries” as follows:

  1. Surviving spouse;
  2. Minor child of the plan participant;
  3. Disabled beneficiary;
  4. Chronically ill beneficiary; and
  5. Beneficiary that is less than 10 years younger than the plan participant.

Depending on a family’s plans for wealth transfer and preservation, these five exceptions may be broad enough so as to not require significant action or changes
to plans put in place under the old rules. For other families, these exceptions may be viewed as incredibly narrow and will require significant action and changes to present plans in order to function as desired.

For married couples planning to leave retirement assets to the other spouse, the new law does not present a meaningful change. Surviving spouses qualify as an
eligible designated beneficiary. For single individuals planning to leave retirement assets to a sibling or other individual that is close in age, again, existing plans may function as desired. And of course, anyone planning to leave retirement assets to a qualified charity can still do so.

For many others though, the anticipated beneficiary of retirement accounts may not be an eligible designated beneficiary. One of the most common situations is a
parent leaving retirement assets to a child. While minor children qualify as eligible designated beneficiaries, adult children do not. And even minor children cease to qualify as eligible designated beneficiaries once they reach 18 years of age. As a result, the new 10-year distribution rule will significantly accelerate the time
periods in which children will inherit retirement assets, or in the case of Roth accounts, significantly cut short the period that retirement assets can continue to grow tax-free.

Similarly, anyone who had intended to compound the benefits of their retirement assets, whether tax deferral or tax-free growth, across multiple generations, will
most certainly need to revisit their succession strategy.

Tax Considerations

In addition to potential concerns about the timing of distributions, the 10-year distribution rule also speeds up the time during which tax must be paid. Again, because a non-Roth retirement account is really a big bag of taxable income, the quicker distributions must be taken, the sooner the tax will become due. Accelerating the tax may also result in more tax being due if the increased distributions push beneficiaries into higher tax brackets.

Now more than ever, it is essential to consider your tax brackets, your anticipated future tax brackets, and the anticipated tax brackets of your beneficiaries to
determine how to best structure distributions to minimize the tax bill. For some, their marginal tax rate might encourage liquidation of retirement accounts now or over time and acceleration of the tax due in as tax-neutral of a manner as possible. Roth conversions might also make sense.

For others, depending on the circumstances, planning strategies might be employed to mitigate the tax bill. For example, retirement assets might be able to be directed toward certain family members or beneficiaries that qualify as an eligible designated beneficiary, and non-retirement assets could be allocated to
non-eligible designated beneficiaries. Individuals that are charitably inclined might consider directing retirement accounts to charities. Similarly, implementing a
charitable remainder trust may completely eliminate tax due on retirement accounts, while still providing a lifetime payout to the non-charitable beneficiaries.
This is by no means an exhaustive list. Rather, the point is that now might be a good time to revisit your existing financial and estate plans to determine what
planning opportunities may exist that could benefit you, your family, or your business.

Life Insurance

For those who decide not to employ tax-minimization strategies or who decide that none of the available strategies are a good fit for their circumstances, efforts might be best spent determining how their beneficiaries will pay the accelerated tax under the SECURE Act when retirement assets are distributed. Life insurance has always been a hallmark of financial and estate planning. Now more than ever, life insurance should be revisited to determine whether existing policies will provide sufficient benefits to cover any increased tax obligations that may become due in the future. And remember, while life insurance benefits are income tax free, they may be included in a decedent’s taxable estate and subject to estate tax.

Conduit Trust vs. Accumulation Trust

If you have an existing trust, the 10-year distribution rule may also significantly alter how the trust functions. While the trust will probably still “work,” the result
under the SECURE Act might be very different than the intent when the trust was created. For example, many trusts previously designed to accept retirement
accounts may be structured as conduit trusts that purport to require the trustee to annually withdraw from a retirement plan and pay to the beneficiaries the required minimum distribution. But under the new regime, there are no longer any required minimum distributions for non-eligible designated beneficiaries. This could result in no distributions being made to a beneficiary for nearly ten years, which might be a good or bad thing, depending on the circumstances.

For some, accumulation trusts, rather than conduit trusts, may now be a better option. Those who intended to have their retirement accounts paid out to a beneficiary based upon life expectancy could still accomplish this goal using an accumulation trust. The retirement account would still have to be distributed to the trust within the 10-year period, but the trust could then hold the assets, reinvest as appropriate, and distribute them to the beneficiaries over whatever longer period is desired. The drawback, of course, is the tax implications. Income paid to or retained by a trust will likely be taxed at a higher tax rate than if the distributions and/or income flowed directly to the end beneficiary. Despite the potential for increased tax, this might be preferred if the desire to extend the distribution period outweighs the desire to minimize the total tax paid.

Notably, the SECURE Act did not modify the previous 5-year distribution rule applicable to non-designated beneficiaries. The new 10-year distribution rule does
not apply to non-designated beneficiaries. As a result, it will still be important that a trust anticipated to receive retirement assets still function as a see-through trust to qualify as a designated beneficiary. Otherwise, the old 5-year rule will still apply.

Additional Takeaways

  • After the death of an eligible designated beneficiary, the new 10-year distribution rule applies.
  • A designated beneficiary of an account that passed due to a pre-2020 death is treated as eligible designated beneficiary. Upon that beneficiary’s death, the 10-year rule likely applies.
  • The starting age for RMD’s for plan participants was increased from 70½ to 72.
  • The previous 70½ age cap for traditional IRA contributions was removed. Contributions may not be made regardless of age.

Summary

With any legislation, people will be impacted differently depending on their circumstances. The SECURE Act and the changes to the handling of retirement accounts is no different. The important thing is to determine how the SECURE Act will impact you, your family, and your business. Reach out to discuss whether you should:

  1. Change your designated beneficiaries;
  2. Update or implement a trust;
  3. Review current life insurance policies;
  4. Accelerate withdrawals or make Roth conversions; or
  5. Consider other tax-saving strategies.

While the legislation is comprehensive, its integration with the unchanged portions of the Code, implementation, and meaning of certain provisions will surely be the subject of further guidance and clarification by Congress, the IRS, and the Treasury.

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2020-03-27T15:57:06-05:00 March 16th, 2020|Estate Planning, News|