The SECURE (Setting Every Community Up For Retirement Enhancement) Act (the “Act”) was included and passed as Division O of the Further Consolidated Appropriations Act of 2020. The Act is effective January 1, 2020, and includes many provisions intended to increase retirement savings by making it easier for employers, particularly small employers, to offer retirement savings plans and by increasing the types of employees eligible to contribute to retirement plans.
For individuals, the Act also includes several important provisions that will have a wide ranging impact.
Increase to Age of Required Beginning Date. Previously, most individuals were required to begin taking distributions from retirement accounts in the year in which the individual attained age 70 1/2. For individuals who did not attain age 70 1/2 in 2019 or earlier, the Act increases the age at which withdrawals are required to begin to 72. Note: The prior law regarding Roth accounts remains in effect (i.e., for Roth accounts, there is no age for at which the employee or IRA account owner is required to begin withdrawing funds).
Repeal of Maximum Age for Traditional IRA Contributions. The Act repeals the prior rule that had prohibited retirement account contributions from and after the year an individual attains age 70 1/2. Now, individuals who have attained age 70 1/2 may continue to make contributions from amounts received as compensation or from earned income.
Significant Changes to Required Distributions From Inherited Retirement Accounts – The End of the Stretch IRA. As part of the Act’s revenue provisions, the Act makes significant changes to the required minimum distributions from inherited retirement accounts and effectively ends the stretch IRA. Shortening the time period over which retirement accounts are required to be distributed is considered a revenue enhancement because any amount withdrawn from a traditional retirement account or IRA is reported as ordinary income on the beneficiary’s income tax return.
Previously, after the employee or IRA account owner (“Owner”) died, beneficiaries other than the Owner’s surviving spouse were required to withdraw the assets from an inherited account (i) within five years of the Owner’s death (the “5-Year Rule”) if the Owner died before the Owner’s required beginning date, (ii) over the Owner’s remaining life expectancy if the Owner died after the Owner’s required beginning date, or (iii) over the life expectancy of an individual designated beneficiary. If structured carefully, certain trusts, such as Conduit Trusts, were able to avoid the 5-Year Rule and use the life expectancy of the oldest trust beneficiary.
The Act completely changes the required minimum distribution rules for beneficiaries other than the Owner’s spouse. Under the Act, for Owners dying after December 31, 2019, most individual beneficiaries are required to use a 10-year payout and non-individual beneficiaries are required to use either a five-year payout or in some instances the deceased Owner’s remaining life expectancy. For individual beneficiaries, the 10-year payout applies to all beneficiaries other than the Owner’s spouse or a beneficiary who is disabled, chronically ill, not more than 10 years younger than the Owner, or the Owner’s child if the child has not reached the age of majority. Notably, the age of majority is not necessarily age 18 or 21. If the child has not completed a “specified course of education,” a child may not be considered to have reached the age of majority until reaching age 26. The regulations do not define what “specified course of education” means. There is also an exception that permits life expectancy payout for certain trusts for the benefit of a disabled or chronically ill beneficiary. In some respects, this exception for trusts for disabled or chronically ill beneficiaries is actually more flexible than the options that were available under the prior law.
These changes to retirement account payouts may have a significant impact to your estate plan.
Under the old rules, many individuals structured their trusts as “Conduit Trusts” to allow the trust to avoid the 5-Year Rule and take advantage of the oldest beneficiary’s life expectancy. However, to qualify as a Conduit Trust, the trust agreement had to provide that any funds withdrawn from the retirement account must be distributed to the beneficiary. In most cases, this was an acceptable trade off when the trust could use the beneficiary’s life expectancy and therefore the retirement account was only required to be withdrawn over a 40- or 50-year period. Now, for someone dying in 2020 or later, the result of a Conduit Trust may be that the child receives 100 percent of the retirement account within 10 years (or maybe even five years—it is uncertain if a Conduit Trust will be eligible for a 10-year payout under the Act). For clients with children in their 20s or 30s or clients with large retirement accounts, this may be much quicker than anticipated.
Similarly, under the old rules, many individuals named their children instead of a trust as the direct beneficiaries of retirement accounts to allow the children to take advantage of the life expectancy payout. Previously, for many individuals the income taxes that would be due when funds were withdrawn were viewed as sufficient disincentive against a child’s imprudence. Now, with a smaller difference in the minimum distribution requirements between trusts and most individuals it may be worth considering whether the protection of a trust is more appropriate.
What Should Individuals Do?
If your retirement accounts are a significant portion of your wealth, you should consult with your advisor about whether to make a change to your beneficiary designations or your trust in light of the Act.
Regardless of the size of your retirement accounts, you should review the beneficiary designations in light of these changes and consider whether they are appropriate. In particular, if a trust is named as the beneficiary of your retirement accounts you should consult with your estate planning attorney to determine whether the designation should be changed or your trust revised.
If you have a child or grandchild that qualifies as disabled or chronically ill, you should consult with your attorney as the Act presents a significant opportunity to structure a trust for that child or grandchild in ways that were not available under prior law.