
The Setting Every Community Up for Retirement Enhancement Act of 2019 (SECURE Act) was signed into law on December 20, 2019 and became effective on January 1, 2020. The SECURE Act makes over two dozen changes to the law affecting retirement benefits and inherited IRAs (Individual Retirement Accounts). The revisions also apply to other defined contribution retirement plans, including 401(k) accounts. As a result, the changes impact estate plans that include assets in an IRA or 401(k) account.
When there are changes to the legal infrastructure of estate planning, such as this, some estate plans will require modification to accommodate the new rules. Whether that is the case for a particular estate plan depends on a number of factors that must be evaluated on an individual basis. If you have an IRA or 401(k), you should consult with a knowledgeable estate planning lawyer about how the SECURE Act affects your estate plan provisions for inheritance of those assets.
Lifetime Payout Period Replaced by Mandatory Full Distribution Within 10 Years for Inherited IRAs and 401(k) Plans
IRAs that have been inherited from a participant who died before January 1, 2020, should be grandfathered and thus free from the new SECURE Act requirements; however, Section 401(b) includes a provision that would apply the SECURE Act payout requirements to a successor designated beneficiary when a designated beneficiary dies before life expectancy.
For example, Father died in 2018, and daughter (age 50) was the designated beneficiary. Daughter dies in 2021, with her son as successor designated beneficiary. Under the old law, because original designated beneficiary died before her life expectancy, the successor designated beneficiary could have continued the stretch-out using the life expectancy of the original designated beneficiary. However, the language of the SECURE Act suggests that the successor designated beneficiary would now be subject to the 10-Year Rule and would not be able to continue the stretch-out even through the original account holder died prior to January 1, 2020.
Elimination of the “Stretch” IRA
The ability to stretch certain inherited IRAs over a designated beneficiary’s life expectancy has been eliminated. An IRA now must be distributed by December 31st of the tenth year following the year in which the retirement account owner dies (herein referred to as the “10-Year Rule”). As a result, designated beneficiaries—the definition of which is unchanged—can no longer stretch an inherited IRA over their lifetime.
Exceptions to the 10-Year Distribution Requirement for an Eligible Designated Beneficiary (EDB)
Though the definition of designated beneficiary has not changed, a new category of five beneficiaries has been created, each known as an eligible designated beneficiary (EDB). An EDB is an exception to the 10-Year Rule. The five EDBs are:
- A surviving spouse;
- A surviving spouse still benefits from life-expectancy withdraw from an IRA or 401(k) account, as an exception under the new law. In addition, RMDs for a surviving spouse who inherits in 2020 or later must begin in the year the deceased spouse would have turned 72 (rather than the previous age of 70½).
- The child of the decedent who is a minor (note that this exception is narrowly drawn; for example, it does not apply to grandchildren even if the child predeceased the participant—so, no “predeceased child step-up” rule as exists);
- A minor child of the account owner is also an EDB. However, when the minor reaches the age of majority, the exception ceases to apply, and the account assets must be distributed within 10 years of the child reaching the age of majority.
- A disabled person;
- A “disabled” beneficiary is eligible for life-expectancy distributions, but the law provides a very limiting definition for a “disabled” beneficiary, as follows:
- “[A]n individual shall be considered to be disabled if he is unable to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment which can be expected to result in death or to be of long-continued and indefinite duration. An individual shall not be considered to be disabled unless he furnishes proof of the existence thereof in such form and manner as the Secretary may require.”
- In order to qualify as an EDB under this provision, if a beneficiary is able to engage in “any substantial gainful activity,” the exception does not apply.
- A chronically ill person; A “chronically ill” beneficiary also is eligible for lifetime distributions, but the law includes a specific and complex definition for this category that is restrictive and limiting.
- An individual who is not more than 10 years younger than the decedent. If the account owner names a beneficiary who is not more than 10 years younger than the owner, the beneficiary is exempted from the 10-year requirement.
Some of the Changes to Retirement Plans Are Taxpayer- Friendly
Under the old rules, once an individual attained age 70 ½, or would do so by the end of the year, no additional contributions could be made. This has been repealed and contributions can continue to be made so long as the participant is employed.
The age at which required minimum distributions (RMDs) must begin has been extended from the year the taxpayer attains age 70 ½ to 72.
An inherited IRA with no designated beneficiary is ineligible for stretch treatment (both lifetime and 10-Year Rule). Such an inherited IRA remains subject to an accelerated withdrawal period. The length of that period depends on whether the participant had died before or after the change to age 72 as the required beginning date (RBD):
- If the death was before the RBD, then the entire account must be withdrawn before five years after the death (more precisely, by December 31 of the year that includes the fifth anniversary of the participant’s death).
- If the death was after the participant’s RBD, then the account must be distributed in annual installments over what would have been the remaining life expectancy of the participant had he not died (some practitioners euphemistically refer to this as the ghost life).
Roth Conversions
In 2010 a tax law eliminated this adjusted income cap of $100,00 for conversions from traditional IRA to a Roth IRA. This resulted in many conversions, especially given the safety net of recharacterization (tax-free conversion back to a traditional IRA if done before the tax return due date for the year of the conversion). However, the 2017 Tax Act diminished the safety of conversion by eliminating the ability to recharacterize.
Conversion triggers current income taxation of the IRA, so the typical analysis was whether the participant or the beneficiary would be in a lower income tax bracket. With an accelerated payout under the 10-Year Rule, it now may be more likely that the beneficiary will be in a higher bracket.
Rarely does it make sense to convert if withdrawals would need to be made to pay the income tax. Plus, as an offset, however, we know that if the participant were in a taxable estate, the dollars used to pay the income tax are in a sense discounted by the avoided estate tax. For example, a client has a taxable estate that includes a $1 million traditional IRA and $1.5 million in cash. If, for simplification, we assume her assets are subject to a 40 percent estate tax, her other assets pay the tax on them, and her cash is used to pay the estate tax on the IRA and the cash, her heirs will receive:
Modifications to Your Current Estate Plan
The SECURE Act will be disruptive for many estate plans and the acceleration of payout may be concerning. When there are changes such as this, some estate plans will require modification to accommodate the new rules. Whether that is the case for your particular estate plan depends on a number of factors that must be evaluated on an individual basis. If you have an IRA or 401(k), you should consult with a knowledgeable estate planning lawyer about how the SECURE Act affects your estate plan provisions for inheritance of those assets.
The attorney at the Skillern Law Firm, PLLC can help. For more information, reach out to us today at (918) 805-2511 or contact@skillernlaw.com.