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How Does The New Federal SECURE Act Affect Your Estate Plan for IRAs & 401(k) Plans?

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.

It’s Important to Update your Estate Planning After A Divorce

Most couples, especially married couples, get their estate planning done together and draft them accordingly. Most of the time, married couples will get a Family Trust, rather than two individual Trusts, and all the beneficiaries/executors/trustees are listed as each other. After the unfortunate event of a divorce, it is extremely important to get your estate planning updated to reflect your life change. Most people’s wishes and ideas about who should receive and manage your property after your death changes after a divorce. The only way to effectively express that intent is to have a new estate plan drafted.

When you get divorced, you absolutely need to update your estate plan. Oklahoma law provides some safeguards for Wills, Trusts, and certain beneficiary designations. Under Oklahoma law, your former spouse does not benefit under your will or Trust, only if your Will or Trust follow the requirements of Oklahoma law. However, these few safeguards are incomplete and will not change your estate plan to exclude your ex-spouse in some situations. The default rule will not revoke any gifts to relatives of your ex-spouse, for example.

It is important to update your Will and/or Trust after a divorce, because the default Oklahoma rules that may or may not apply, and an experienced estate planning attorney will know which ones need updating. One of the best ways to express your new wishes after the divorce is to create or amend your estate plan. This way, you are able to accurately express your new intent with your estate, since divorce usually changes your intent (i.e. leaving the ex-spouse out), and this will ensure that your wishes are clearly communicated.

One important thing to update after a divorce is beneficiary designations on accounts. When you select beneficiaries for life insurance, retirement plans, or bank accounts, you are making a legally significant decision. After you pass away, the institution holding the account will look at your account information, including the death beneficiary, and distribute accordingly. Ex-spouses, if not changed on the account, have a strong chance of benefiting from the account.  Divorce has an very limited effect, if any, on these beneficiary type arrangements.

For example, most people hold a lot of assets in their IRA, 401(k), or other retirement plan. Most people do not realize that these retirement plans are governed by Federal law, and no state (including Oklahoma) can use a divorce decree/order to overcome the beneficiary designation on your retirement plan. This means your ex-spouse will benefit if the beneficiary is not changed. You absolutely have to change the beneficiaries after a divorce decree is final to express your new intent.

Most people have many other things on their minds if they have just gone through a divorce, but it is very important to contact an estate planning attorney, or be active in keeping your estate plan up-to-date. Please contact the Skillern Law Firm, PLLC if you need your estate plan updated or created.

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